When banking systems meet currencies

Abstract

In this paper, we examine the link of investment portfolio decisions of households and investment on international capital flows. I extend Bencivenga and Smith (1991)’s overlapping generation model to an open economy and combine with capital market imperfections in Kiyotake and Moore (1997) to address how the portfolio decisions of one countrty might affect that of the other country. In this general equilibrium framework with flexible exchange rate, I find that the investment portfolio deicisions of households are crucial for the directions of capital inflows. In other words, the portfolio decision of individuals in one country is crucial for the deposit and loan rate, which would affect where the capital inflows from the foreign investors.