relatively low saving and high investment whereas an older workforce may be associated with a rise
in the net foreign asset position, as the saving for retirement motive kicks in and domestic investment
falls. For this reason, we will employ the entire age distribution in our empirical work.
Finally, some authors have recently modeled the determination of net foreign asset positions
in a stylized mean-variance portfolio framework, with the demand and supply for domestic and
foreign assets being determined by risk and return characteristics and by the profiles of investors (see
Calderon, Loayza and Servén, 2000, Kraay, Loayza, Servén and Ventura, 2000 and Edwards, 2001).
As the preceding discussion has highlighted, our fundamentals — output per capita, public debt and
demography — potentially affect these factors in complex ways. Among the channels not already
discussed, output per capita and years-to-retirement may plausibly affect the degree of risk aversion.
However, the relation between risk aversion and the net foreign asset position depends on whether the
“safe” asset is domestic or foreign, which is typically a model-specific choice.
3.2 PREVIOUS EMPIRICAL WORK
Masson, Kremers and Horne (1994) is one of the very limited number of studies focusing on
the evolution of net foreign assets.8 In their country studies of the United States, Japan and Germany
over the period 1960-85, they relate net foreign asset positions to the overall dependency ratio and the
level of government debt, but do not include the level of income per capita.9 They find evidence of a
long run relation between these variables, and highlight the role of feedback mechanisms working
through absorption in the adjustment process towards the long-run equilibrium. Calderon, Loayza and
Servén (2000) relate the evolution of net foreign assets to composite measures of risk and return; they
find support for their specification, particularly for countries with low barriers to international capital
movements.
Taylor (1994), Higgins (1998) and Herbertsson and Zoega (1999) have provided some
8 Halevi (1971) and Roldos (1996) provide some empirical evidence on the “stages of the balance of payments”
hypothesis.
9 In a study of OECD countries, Bayoumi and Gagnon (1996) also control for fiscal and demographic effects
but their primary focus is on the effects of inflation on net foreign asset positions.