Trade in Nominal Assets: Monetary Policy, and Price Level and Exchange Rate Risk

Abstract

In a previous paper, Trade in Risky Assets, I have analyzed the pattern of international trade in risky real assets between barter economies, relying on the Law of Comparative Advantage and using autarky asset price differences to predict the pattern of asset trade. In this paper the analysis is extended to international trade in nominal assets (assets with returns paid in currencies) between monetary economies. The risk chracteristics of real returns on nominal assets depend on price level and exchange rate risk, and therefore on monetary policy. It is examined how different combinations of monetary policies and exchange rate regimes affect nominal assets' return risk characteristics, their autarky perices, and hence their trade pattern, when countries differ with respect to their outputs or their attitudes towards risk. When world asset markets are incomplete, different monetary policies and exchange rate regimes have dramatic effects on risk characteristics of home and foreign currency bonds and on the trade pattern in these assets, as well as on aggregate capital and current accounts.