The Impact of Foreign Investors on the US Economy as a Source of Alternative Risk Premia

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This article: i) explains why international financial contagion could have been a major cause of structural changes in the US economy and specific major US industries (housing, retailing, etc.) during 1995-2003; ii) critiques traditional methods of modeling international financial contagion; iii) introduced new theories of Structural Change; iv) introduces new Dynamical Systems models/theories for determining the effect of foreign investors on an economy within the context of various “Parity Anomalies” (that sometimes arise from trade imbalances; financial crises; shocks; etc.) - these new models can be used to generate alternative risk premia. This article is the first to: i) apply the combination of “Turning Points Analysis” and Dynamic Programming to decision making in International Finance/Economics; ii) explain the relationship between social choice functions and mechanism Design on one hand, and portfolio management algorithms and capital allocation. The Dynamical Systems models introduced herein are third-order or fourth-order dynamic programming because they consist of distinct sub-solutions which are combined into one solution; and they have at least three heirachical orders/levels of solution processes – the first level (Level-1) consists of generation of variables; and Level-2 consists of generation of “non-equilibrium conditions” using inequalities; and Level-3 consists of assignment of scores to such conditions; and Level-4 consists of weighted averaging of the scores for “Composite Decision-Making”. While this article focuses on bond and currency markets, the models and theories introduced in this article can also be applied to the analysis of the effects of foreign investors on stock markets, commodity markets and real estate markets. Some of the innovations in this article are that: i) Turning-Points and “Foreign Investors’ Effects” are analyzed and modelled as large-scale aggregated Network-Decisions (or sets of Network-Decisions) in Complex Systems, wherein Turning-Points and Foreign Investors’ Effects begin, evolve and end as groupings of decisions made by corporations, institutional investors and government agencies over time. ii) Turning-Points and “Foreign Investors Effects” are modelled as being subject to “Short-term Chaos” (short-term sensitivity to “Initial Conditions”, time and interactions among variables/processes) which is or can be muted in many cases by changes in “Aggregated Decisions” and Decision Patterns.