Global Imbalances And Financial Risks Under The Risk Preference Differences

This paper establishes a mean-variance model within heterogeneous risk preferences of investors to explain a set of puzzles on global imbalances.Emerging markets met higher risk aversion compared with advanced economies due to a series of financial crises and institutional shocks they had suffered since late 1990s.As a result they prefer low-risk assets so as to lend in the global market and obtain trade surpluses, while the advanced borrow to fund their high-return/risk items and receive exorbitant earnings from overseas investments to maintain their current account. Shock analysis tells that discrepancy in risk preferences would trigger continuous external imbalances if there happened a negative impact.Economic catch-up in emerging areas implies a decline of wealth share in mature markets and the risk-free interest rate goes down as well. With the leverage rise is an accumulation of risk, which ultimately leads to the global financial crisis. Recalibration of risk preferences after the crisis may amend the mechanism that results in the imbalance and thus push the world economy upon the harmonious track.Different from previous studies, our research focuses on the demand side of assets and introduces the risk factor into the traditional portfolio model, in order to explore the formation and development of global imbalances within heterogeneous risk preferences. We also discuss the rebalance path of world economy on the basis of our model.