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and (ii) weights based on the geography of cross-border bank assets, taken from the BIS.30
We use long-term interest rates, based on OECD data—results are analogous if we use an
average of short- and long-term rates. For debt liabilities, we track yields and returns with
the long-term domestic interest rate and the domestic bond return, respectively.31
We also investigate whether the returns on foreign assets provide diversification against
variation in domestic financial returns. The specification is
rBOP,FA =αi+β*rikMt + εijt (10)
ijt i ikt ijt
where rijBt OP,FA is the return on some category of foreign assets and rikMt is the return on
some category of foreign liabilities.
Finally, we address the relation between rates of return and real exchange rate movements.
As discussed in the previous subsection, the co-variation between real returns in home
currency and foreign currency depends on their correlations with real exchange rate
fluctuations. For this reason, we report these correlations32
ρ(rit, riUtS); ρ(rit, drerusit); ρ(riUtS, drerusit) (11)
D. Results
As a prelude to the investigation of returns on individual investment categories, we first
show that the aggregate returns on foreign assets and liabilities depend on the composition
of the international balance sheet between equity- and non-equity components. Figures 8
30 For the latter, we know the relative proportions of lending in domestic currency versus
other currencies. Accordingly, the yield on foreign assets depends on the domestic interest
rate and on the weighted average of foreign interest rates.
31Since some debt liabilities are contracted in foreign currencies, this will be an imperfect
approach. Of course, this consideration is much more important for emerging market
economies, not included in this paper.
32 This approach is simplified by the assumption that dollar real returns are a good
representation of the ‘external’ market.