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**Contents lists available at ScienceDirect
**

Research in International Business

and Finance

j ournal homepage: www. el sevi er. com/ l ocat e/ ri baf

The current account and stock returns

Yoshihiro Kitamura

Faculty of Economics, University of Toyama, 3190 Gofuku, Toyama, 930-8555 Japan

a r t i c l e i n f o

Article history:

Received 18 February 2008

Received in revised form 16 October 2008

Accepted 11 November 2008

Available online 19 November 2008

JEL classiﬁcation:

F32 (Current Account Adjustment

Short-Term Capital Movements)

F41 (Open Economy Macroeconomics)

Keywords:

Current account

Permanent income

Stock return

a b s t r a c t

In this paper, I use stock return data to test an intertemporal model

of the current account. I ﬁnd that the model performs well in

three countries: the U.K., Canada, and Japan. Hall [Hall, R.E., 1978.

Stochastic implication of the life cycle-permanent income hypoth-

esis: theory and evidence. J. Polit. Econ. 86 (6), 971–987] points

out that because stock price predicts the future state of the econ-

omy, it predicts consumption. Assuming that consumptiondepends

on permanent income, my empirical ﬁnding indicates that a rep-

resentative agent smoothes consumption based on stock market

information. Inother words, stock market returns yieldinformation

about permanent income.

© 2008 Elsevier B.V. All rights reserved.

1. Introduction

This paper suggests that the consumption smoothing behavior of a representative agent is well

depicted once stock returns are considered. Given that consumption is based on permanent income,

stock returns inform permanent income.

Acountry that faces transitory decreases in income is expected to smooth consumption by borrow-

ing in the world market. Hence, it will run a current account deﬁcit. The intertemporal approach views

the current account

1

as the outcome of forward-looking dynamic saving and investment decisions

intended to smooth consumption. Intertemporal approaches to the current account (hereafter, ICA)

became common in the early 1980s. Lucas’s (1976) inﬂuential critique led many studies to focus on

the ICA (Obstfeld and Rogoff, 1995, p. 1732). The application of Lucas’s critique to the ICA suggests that

saving and investment decisions should result from forward-looking calculations based on expecta-

tions of future productivity growth, the real interest rate, and other factors (e.g., Sachs, 1982). Simple

E-mail address: kitamu@eco.u-toyama.ac.jp.

1

In this study, a current account refers to a current account balance.

0275-5319/$ – see front matter © 2008 Elsevier B.V. All rights reserved.

doi:10.1016/j.ribaf.2008.11.002

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 303

versions of the ICA have been tested empirically in Sheffrin and Woo (1990), Otto (1992), and Ghosh

(1995). These studies assume that the country in consideration is small, and they adopt present value

tests developed by Campbell and Shiller (1987). However the results from these simple models are

inconsistent with the small country assumption: the ﬁt of the ICA is better in some larger countries

than in smaller ones.

2

Thus, the explanatory power of the ICA is insufﬁcient in some cases, showing

the need to improve the model.

Previous studies have used a representative agent who is forward-looking and can borrowand lend

at a constant world interest rate. However, the current account is likely to be affected by changes in the

interest rate, and these studies fail to take those effects into consideration. Sachs (1982) argues that

the current account can be separated into two components: a consumption-smoothing motive and

a consumption-tilting motive. The consumption-tilting motive makes a country tilt its consumption

toward the present or the future, depending on the magnitude of the world interest rate in relation

to its subjective discount rate. In other words, if the interest rate is higher than the discount rate, the

country saves in the international capital market. This indicates the possibility that the change in the

world interest rate induces a change in consumption. This leads, in turn, to a change in the current

account. Bergin and Sheffrin (2000) succeeded in accommodating a time-varying interest rate into

their empirical model. They ﬁnd that taking both the interest rate and exchange rate into consideration

improves the ﬁt of the ICA model.

Drawing on the work of Bergin and Sheffrin (2000), I focus on the role of stock returns in the ICA. As

mentioned after, the ICAmodel performs well when stock market returns are taken into consideration.

This ﬁnding is consistent with the permanent income hypothesis: due to its wealth and leading effects

mentioned in the following section, a stock price adjustment causes or signals a change in permanent

income. In the permanent income model of consumption, the change in permanent income affects

the country’s consumption, amount of savings, and therefore net foreign asset position. Moreover, the

adjustment leads to movement in the current account even when a stock price adjustment is unrelated

to changes in permanent income. According to the permanent income model of consumption, when

a stock price adjustment temporarily increases current income, agents save a part of any transitory

increase in income in order to smooth their intertemporal consumption.

This paper is organized as follows. In Section 2, I summarize the theoretical research on impacts

of stock market movements on the current account and the economic model. Section 3 describes the

data used in empirical analysis. Section 4 presents the empirical results for three nations: the U.K.,

Canada, and Japan. The ICA has already been shown to perform poorly in the case of the U.K., Canada

(Sheffrin and Woo, 1990), and Japan (Ghosh, 1995). I show here that when stock market returns are

considered, the results of the model differ fromthose of previous studies. Finally, Section 5 concludes.

2. The theory and model

2.1. Impact of a stock market on a current account: a theoretical background

The channel through which stock price adjustments affect current accounts is attributed to a coun-

try’s consumption behavior. A stock price adjustment affecting consumption may affect the total

amount of country savings, and therefore the net foreign assets position. The effects of stock price

on consumption are divided into three categories: wealth, uncertainty, and leading indicator effects

(see Apergis and Miller, 2006).

Using the permanent income hypothesis, Hall (1978) argues that a stock price adjustment causes a

change in permanent income – the so-called wealth effect – and thus a change in consumption. Glick

and Rogoff (1995) showthat a positive permanent country-speciﬁc productivity shock induces invest-

ment and leads to a higher future capital stock, thereby raising permanent income. If new permanent

income surpasses current income, the current account enters a deﬁcit, since a country’s consumption

is based on foreign borrowing. A purely transitory positive shock results in a current account surplus,

2

Otto (1992) empirically investigates the ﬁt of the ICA in the U.S. and Canada and his result concludes that the ﬁt in the U.S.

is much better than one in Canada.

304 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

since agents save a part of their transitory increase of income. It is plausible that these country-speciﬁc

shocks appear in stock markets. Thus, this paper introduces a country-speciﬁc deﬁnition of the stock

market variable: the difference between the country and world real stock returns.

The secondeffect is investor uncertainty fromstock price decreases, whichreduces expenditures on

durable goods (Romer, 1990). Investor uncertainty changes the path of durable consumption, leading

to a temporary movement in the current account. In addition, in relation to durable consumption,

˙

Is¸ can (2002) develops a present value model of ICA that incorporates durable consumption. He argues

that a permanent shock in net output causes durable stock to adjust to new levels that are optimal for

the new net output. This adjustment in durable stock leads to a change in aggregated consumption

spending and a temporary movement in the current account. As mentioned above, a permanent shock

in net output may appear in the stock market, allowing us to observe the channel through which stock

price adjustments affect the current account. This observation is potentially related to the theoretical

background of

˙

Is¸ can (2002).

PoterbaandSamwick(1995) proposealeadingindicator effect, wherebycurrent stockpricechanges

predict future movements in income. Mercereau (2003a) develops a current account model that per-

mits an arbitrary number of risky assets, including stocks, to determine an optimal portfolio. The main

implication of this model is that a current account may help to predict future stock market perfor-

mance. This is due to the fact that a current account is a consequence of agents’ optimal consumption

behavior and should therefore contain all available information, including current and future stock

market performance. Based on the model of Mercereau (2003a), Mercereau (2003b) runs the Granger

causality test and ﬁnds evidence that the current account of the U.S. is a somewhat good predictor for

future stock performance in the U.S.

In summary, it is plausible to consider several channels through which stock price adjustment

affects consumption and therefore a current account. In contrast, Bergin and Sheffrin (2000) develop

a model of ICA that incorporates time-varying interest rates, which improves model performance

beyond those of previous studies. This is due to the fact that the time-varying world interest rate

captures external shocks in borrowing and lending in the international market. Therefore, the model

can reproduce agents’ intertemporal consumption smoothing behavior.

Replacing the world interest rate in Bergin and Sheffrin (2000) with several stock returns, I perform

present value tests of ICA and investigate which factor – the world interest rate or stock price – plays

the more dominant role in the movement of the current account. Since the model developed by Bergin

and Sheffrin (2000) enables us to implement a direct test for the present value model of ICA, we can

evaluate the relationship between the stock market and current account. We do this using an approach

different from that of Mercereau (2003b); the latter ﬁnds the Granger causality from current account

to future stock performance.

2.2. The model

The model used in the present study draws heavily from the work of Bergin and Sheffrin (2000)

(hereafter B–S). B–Sassumes arepresentativeagent inasmall openeconomy. Themodel is summarized

by the following set of equations:

max £

t

∞

s=t

ˇ

s−t

U(C

1s

, C

Ns

) (1)

s.t. Y

t

−(C

1t

+P

t

C

Nt

) −l

t

−C

t

+r

t

8

t−1

= 8

t

−8

t−1

, (2)

where

U(C

1t,

C

Nt,

) =

(C

u

1t

C

1−u

Nt

)

1−o

1 −o

, o : 0, o / = 1, 0 - u - 1,

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 305

C

Tt

=real consumption of a traded good; C

Nt

=real consumption of a nontraded goods; P

t

=the relative

price of home nontraded goods in terms of traded goods; ˇ=subjective discount factor

3

; Y

t

=real

output level; I

t

= real investment; G

t

=real government spending; B

t

=stock of assets (equity); r

t

=real

stock return; 1/o =the elasticity of intertemporal substitution; a =the share of traded goods in the ﬁnal

private consumption.

4

Maximizing (1) subjected to (2) yields the Euler equation. Assuming that the real return and

consumption are jointly homoscedastic and lognormal, the Euler equation is written in log form:

£

t

[^c

t+1

] = ¡£

t

[r

∗

t+1

], (3)

r

∗

t

= r

t

+

_

1 −¡

¡

(1 −u)

_

^p

t

+ccns., (4)

where ¡ =1/o, ^c

t+1

= ln C

t+1

−ln C

t

(C

t

=C

Tt

+P

t

C

Nt

), ^p

t+1

= ln P

t+1

−ln P

t

, and the approximation

ln(1+r) ≈r is used. The variances and covariances in Eq. (4) are assumed to be constant. B–S considers

traded and nontraded goods, showing that the optimal consumption proﬁle in Eq. (3) is inﬂuenced by

the consumption-based interest rate r

∗

t

, which reﬂects both the real interest rate and the relative price

of nontraded goods (real exchange rate). Using log linearization, B–S obtains the following equation:

−£

t

∞

i=1

ˇ

i

[^nc

t+i

−¡r

∗

t+i

] = nc

t

−c

t

(≡ cu

∗

t

), (5)

where c

t

=lnC

t

and ^nc

t

= ln NO

t

−ln NO

t−1

. NO is net output (net cash ﬂow) deﬁned as NO

t

=

Y

t

−l

t

−C

t

. Following B–S, I label this transformed representation of the current account as ca

*

(≡no

t

−c

t

). All variables are demeaned, so the constant termis ignored. The current account is deﬁned

as CA

t

≡NO

t

−C

t

, and the right hand side of (5) is similar to the deﬁnition of the current account, except

that its components are in log terms.

In Eq. (5), a present current account ca

*

is expressed with discount values of a future change in

net output (^no) and a future interest rate (r

∗

t

). This expression allows us to see the ICA as a present

discount model. Assuming ¡ ≥0, Eq. (5) indicates that, if the rate r

∗

t

is expected to rise temporarily over

its average, consumption smoothing behavior increases the current account. This study empirically

examines the ICA model in the form of Eq. (5), focusing on the relationship between stock returns and

the current account.

To test the restriction of Eq. (5), I need some proxies for the expected values that Eq. (5) contains.

To obtain the proxies for the expected values, I adopt present value tests developed by Campbell and

Shiller (1987) and estimate a vector auto-regressive (VAR) system as follows:

_

^nc

t

cu

∗

t

r

∗

t

_

=

_

u

11

u

12

u

13

u

21

u

22

u

23

u

31

u

32

u

33

__

^nc

t−1

cu

∗

t−1

r

∗

t−1

_

+

_

ε

1t

ε

2t

ε

3t

_

. (6)

More compactly:

Z

t

= AZ

t−1

+U

t

,

where Z

t

≡ [^nc

t

, cu

∗

t

, r

∗

t

]

**and A is the transition matrix of the VAR and E
**

t

(Z

t+i

) =A

i

Z

t

. U

t

is the dis-

turbance matrix of εs. It is easy to generalize the form of Eq. (6) to incorporate higher orders of the

VAR in the ﬁrst order form (Sargent, 1987, pp. 272–273). Following B–S, I set the lag length of VAR to

a value between 1 and 3. The lag length of VAR is determined according to the Schwartz information

criterion (SIC). With Eq. (6), the inﬁnite sum of Eq. (5) is expressed as follows:

cu

∗

t

= −(G

1

−¡G

2

)ˇA(I −ˇA)

−1

_

^nc

t

cu

∗

t

r

∗

t

_

=

_

1

nc

1

cu

1

r

¸

_

^nc

t

cu

∗

t

r

∗

t

_

, (7)

3

The discount factor ˇ is set to 0.97 in this study.

4

Following B-S, I ﬁx this parameter to 0.5.

306 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

Table 1

Data used in this study.

Category IFS series

Private consumption 96f

Investment 93e+93i

Government expenditure 91f

Stock index 62

Money market rates 60b

Gross domestic product 99b

Price index 64

Effective nominal exchange rate nec

Nominal exchange rate ae

Population 99z

GDP deﬂator 99bvr

Note: All data are from the International Financial Statistics (online). All series are seasonally adjusted at annual rates. NO (the

net output) =99b−(93e +93i) −91f; ca

*

(current account) =lnNO−ln96f.

where G

1

=[100] and G

2

=[001]. Under the null hypothesis, [1

no

1

ca

1

r

] =[010] holds in Eq.

(7). Let equal [1

no

1

ca

1

r

] and

˜

be the difference between the actual and [010]. Then

˜

((∂]∂A)V(∂]∂A)

)

−1

˜

**is the Wald statistic, which has a chi-squared distribution with three
**

degrees of freedom, where V is the variance-covariance matrix of the parameters of VAR. Let cu

∗

t

and

´

cu

∗

t

be actual and predicted current accounts, respectively. The residual sum of squares (RSS) is

deﬁned as

1

t=1

[cu

∗

t

−

´

cu

∗

t

]

2

. I searched ¡s to minimize the RSS. This method gives us more accurate

prediction of Eq. (7) than ¡s, which minimize the Wald statistic.

5

3. Data

I test Eq. (7) using quarterly data from three countries: the U.K., Canada, and Japan. For all three

countries, the data cover the period from Q1 1960 to Q4 2007. Except for the U.K. stock price, all data

are fromthe International Financial Statistics (IFS). The IFS does not provide U.K. stock price index data

fromQ2 1999, so I replace the missing data using a corrected FTSE index fromYahoo Finance. To adjust

the series of FTSE to IFS stock index, I calculate the ratio of the IFS stock index to the FTSE inQ11999and

multiply the series of FTSE index by this ratio. The consumption price index for industrial countries,

which B–S uses to calculate the real exchange rate, is available from Q1 1968. Alternatively, I adopt a

weighted average of G7 consumption price indices to obtain an industrial one; this calculation assigns

time-varying weights to each country based on the proportion of total G7 GDP that corresponds to

that country’s GDP. The other data series are the same as those in B–S. Details of the data are shown

in Table 1.

Details for data creation, such as the consumption based interest rate in Eq. (4), are omitted because

this paper adopts the same method of B–S. Readers can ﬁnd the details in Section 2 of B–S. Applying

the same method, I obtain the net output (no

t

) and current account (cu

∗

t

) for each country. In order to

compare the model performance, I consider the ﬁve ﬁnancial variables for r

∗

t

in Eq. (4). A comparison

will reveal which is more informative for consumption smoothing. I adopt the B–S method to compute

the world real interest rate. When r

∗

t

in Eq. (4) is the world real interest rate, I label this model as model

1 (the benchmark). This computation technique also provides the world real stock return (model 2).

In addition, I calculate the country-speciﬁc deﬁnition of the stock market variable as the difference

betweenthe country andthe worldreal stockreturns (model 3). I thencompute the worldandcountry-

speciﬁc real stock returns (models 4 and 5, respectively), ignoring the effects of exchange rate [a =1 in

Eq. (4)].

Table 2 summarizes the ﬁve models, which are tested in the following section.

5

B-S adopts the later methodto obtainthe parameter ¡. The results of ¡s, whichminimize the Waldstatistic, are also available

upon request.

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 307

Table 2

Summary of the ﬁve models.

Model The effect of exchange rate Interest rate/stock variable r

t

in Eq. (4)

Model 1 (benchmark) Yes [a =0.5 in Eq. (4)] The world interest rate

Model 2 Yes [a =0.5 in Eq. (4)] The world stock return

Model 3 Yes [a =0.5 in Eq. (4)] Country-speciﬁc stock return

Model 4 No [a =1 in Eq. (4)] The world stock return

Model 5 No [a =1 in Eq. (4)] Country-speciﬁc stock return

Note: The world interest rate (stock return) is a weighted average of G7 real money market rates (real stock return) using time-

varying weights for each country based on the proportion of total G7 GDP that corresponds to that country’s GDP. More detail

can be found in Section 2 of Bergin and Sheffrin (2000). The country-speciﬁc stock return is the difference between the country

and the world real stock returns.

4. Results

4.1. VAR estimation

In this section, the ICA model (Eq. (7)) is analyzed using the data explained in the previous section.

The ﬁrst model is model 1, developed by B–S. Model 1 suggests that consumption reacts to changes

in the world interest rate calculated fromthe money market interest rates of G7 countries and the real

exchange rate. Model 1 is a benchmark for the other four, which take into consideration the effects

of stock returns. If the other four models (models 2–5) perform better than model 1, then the effect

of the stock return is a more important factor than the interest rate for the ICA model. This result is

consistent with Mercereau (2003a,b).

To test Eq. (7), it is necessary to estimate three variables (^no, ca

*

and r

∗

t

) in the VAR model and

obtain the coefﬁcient matrix A for each model. The estimation results of VAR are shown in Table 3.

Table 3 reports the sums of estimated parameters of each independent variable for one dependent

variable. The numbers in parenthesis are the p-values for the chi-squared test (the Granger causality

test), in which the null is that all the parameters of each independent variable are zero.

6

The “max

(min) eig” reports the maximum(minimum) modulus of eigenvalues of the coefﬁcient matrix A in Eq.

(6). Table 3 shows that the modulus of all eigenvalues lies inside the unit circle, indicating that the

VAR system satisﬁes its stability condition (see Hamilton, 1994).

I also check the assumption that variables in the VAR, ^no, ca

*

, and the ﬁnancial variables (r

*

s), are

stationary. I perform the augmented Dickey–Fuller (ADF) unit-root test for a range of lags 1-5, for all

variables. Table 4 provides the ADF unit-root test

7

results for each country during the sample period.

For all variables, the ADF test rejects the presence of a unit root at least 5 percent signiﬁcant level for

all numbers of lags. This result suggests that all variables can be treated as stationary.

4.2. Empirical results

Following VAR estimation, I calculate the current account predicted by each ICA model using an

estimated VAR coefﬁcient matrix. The each empirical result of the ICA is summarized in Table 5.

Table 5 reports the estimated in Eq. (7) and some statistics for evaluating model performance.

The numbers in square brackets are standard errors for each estimated factor of . A value of ¡ is

obtained that minimizes the RSS. The volatility of the predicted current account (cˆ u

∗

) is normalized to

the volatility of the actual current account (ca

*

) in the “VR” rowof Table 5. This variance ratio is used as

anindex to see whether eachmodel captures the actual change ina current account. If the ratio is equal

to one, then the model perfectly captures the volatility of the actual current account. The “Wald stat”

is the Wald test statistic for the overall ﬁt of the model and “p-value” relates to this statistic. The last

6

The poor statistical signiﬁcance of stock variables may imply no validity of stock variables for the ICA model. This issue is

discussed in Section 4.3.

7

I do not include a time trend or a constant in the ADF regression. Because all series are demeaned, they ﬂuctuate around a

level of zero without apparent trend in the sample.

3

0

8

Y

.

K

i

t

a

m

u

r

a

/

R

e

s

e

a

r

c

h

i

n

I

n

t

e

r

n

a

t

i

o

n

a

l

B

u

s

i

n

e

s

s

a

n

d

F

i

n

a

n

c

e

2

3

(

2

0

0

9

)

3

0

2

–

3

2

1

Table 3

VAR estimation.

Independent variable Model 1 Model 2 Model 3 Model 4 Model 5

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

(Part A) The U.K.

l^no

t−i

−0.323 −0.087 0.119 −0.329 −0.080 1.593 −0.312 −0.085 0.833 −0.330 −0.079 1.244 −0.312 −0.084 0.542

(0.000) (0.188) (0.139) (0.000) (0.224) (0.137) (0.000) (0.203) (0.511) (0.000) (0.230) (0.245) (0.000) (0.209) (0.671)

cu

∗

t−i

−0.006 0.923 0.093 −0.004 0.923 0.316 0.005 0.920 0.690 −0.004 0.923 0.326 0.004 0.920 0.707

(0.875) (0.000) (0.020) (0.907) (0.000) (0.543) (0.893) (0.000) (0.259) (0.904) (0.000) (0.529) (0.906) (0.000) (0.251)

r

∗

t−i

0.025 −0.018 0.631 0.004 −0.005 0.325 −0.004 −1.7E−04 0.091 0.005 −0.005 0.330 −0.004 −0.001 0.083

(0.613) (0.690) (0.000) (0.361) (0.240) (0.000) (0.294) (0.966) (0.223) (0.325) (0.201) (0.000) (0.327) (0.895) (0.266)

R

2

0.108 0.822 0.469 0.111 0.823 0.130 0.112 0.822 0.025 0.112 0.824 0.128 0.112 0.822 0.020

NOB 185 185 185 185 185

Lag (=i) 1 1 1 1 1

max eig 0.917 0.920 0.919 0.920 0.920

min eig 0.327 0.338 0.081 0.339 0.077

(Part B) Canada

l^no

t−I

−0.246 −0.077 −0.222 −0.240 −0.085 −1.617 −0.248 −0.082 −0.507 −0.243 −0.084 −0.862 −0.246 −0.084 0.176

(0.000) (0.214) (0.126) (0.001) (0.172) (0.120) (0.000) (0.190) (0.527) (0.001) (0.172) (0.391) (0.000) (0.176) (0.827)

cu

∗

t−i

−0.056 0.885 0.193 −0.065 0.897 0.668 −0.057 0.895 0.429 −0.063 0.897 0.365 −0.059 0.896 0.121

(0.162) (0.000) (0.019) (0.093) (0.000) (0.246) (0.139) (0.000) (0.329) (0.104) (0.000) (0.510) (0.129) (0.000) (0.784)

r

∗

t−i

−0.009 0.033 0.385 0.007 −0.001 0.361 −0.003 0.002 0.256 0.008 −0.002 0.340 −0.002 −9.7E−05 0.241

(0.762) (0.225) (0.000) (0.154) (0.815) (0.000) (0.619) (0.751) (0.000) (0.108) (0.584) (0.000) (0.698) (0.986) (0.001)

R

2

0.083 0.794 0.230 0.092 0.792 0.155 0.083 0.792 0.077 0.095 0.792 0.122 0.083 0.792 0.058

NOB 185 185 185 185 185

Lag (=i) 1 1 1 1 1

max eig 0.902 0.900 0.900 0.899 0.900

min eig 0.252 0.227 0.255 0.236 0.240

(Part C) Japan

l^no

t−i

−2.624 −0.016 0.032 −2.625 −0.017 77.396 −2.625 −0.015 2.158 −2.626 −0.015 0.958 −2.604 −0.013 1.547

(0.000) (0.492) (0.836) (0.000) (0.467) (0.730) (0.000) (0.479) (0.631) (0.000) (0.571) (0.093) (0.000) (0.548) (0.019)

cu

∗

t−i

−0.154 0.881 0.445 −0.149 0.890 346.267 −0.188 0.896 5.352 −0.065 0.877 1.684 −0.146 0.907 1.910

(0.000) (0.000) (0.003) (0.000) (0.000) (0.008) (0.000) (0.000) (0.005) (0.000) (0.000) (0.104) (0.000) (0.000) (0.115)

r

∗

t−i

0.117 0.008 0.328 1.5E−04 −2.8E−06 0.167 0.012 −0.001 0.309 0.003 0.004 0.234 0.035 −0.008 0.354

(0.418) (0.037) (0.002) (0.141) (0.018) (0.010) (0.031) (0.007) (0.002) (0.937) (0.676) (0.000) (0.054) (0.038) (0.000)

R

2

0.844 0.878 0.189 0.846 0.879 0.138 0.849 0.880 0.173 0.842 0.874 0.197 0.848 0.878 0.192

NOB 183 183 182 183 182

Lag (=i) 3 3 3 3 3

max eig 0.955 0.956 0.957 0.953 0.955

min eig 0.392 0.418 0.412 0.087 0.313

Note: The table reports the sums of estimated parameters of each independent variable and the numbers in parenthesis are the p-values for the chi-squared test (the Granger causality test). The null is

that all the parameters of each independent variable are zero. The “max (min) eig” reports the maximum (minimum) modulus of eigenvalues of the coefﬁcient matrix in Eq. (6). “NOB” is the number

of observations and “Lag” is a lag length for the VAR system, which is determined by the Schwartz information criterion.

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3

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–

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9

Table 4

Unit root tests.

Variables ¡ (in Eq. (4)) Lag length of the ADF test

l 2 3 4 5

(Part A) The U.K.

^no

t

−1.392

***

−1.290

***

−1.331

***

−1.345

***

−1.458

***

cu

∗

t

−0.082

**

−0.086

***

−0.093

***

−0.094

***

−0.091

**

The world interest rate (model 1) 0.3171 −0.239

***

−0.152

***

−0.154

***

−0.127

**

−0.132

**

The world stock return with the effect of exchange rate (model 2) 0.1383 −0.762

***

−0.716

***

−0.688

***

−0.746

***

−0.794

***

The country-speciﬁc stock return with the effect of exchange rate (model 3) 0.1389 −0.903

***

−0.942

***

−1.025

***

−1.128

****

−1.118

***

The world stock return without the effect of exchange rate (model 4) −0.748

***

−0.711

***

−0.704

***

−0.746

***

−0.790

***

The country-speciﬁc stock return without the effect of exchange rate (model 5) −0.910

***

−0.932

***

−1.023

***

−1.130

***

−1.104

***

(Part B) Canada

^no

t

−1.310

***

−1.433

***

−1.194

***

−1.147

***

−1.108

***

cu

∗

t

−0.113

***

−0.121

***

−0.107

***

−0.106

***

−0.098**

The world interest rate (model 1) 0.1285 −0.413

***

−0.234

***

−0.227

***

−0.235

***

−0.210

***

The world stock return with the effect of exchange rate (model 2) 0.0575 −0.716

***

−0.637

***

−0.664

***

−0.695

***

−0.728

***

The country-speciﬁc stock return with the effect of exchange rate (model 3) 0.0663 −0.656

***

−0.720

***

−0.725

***

−0.773

***

−0.701

***

The world stock return without the effect of exchange rate (model 4) −0.748

***

−0.711

***

−0.704

***

−0.746

***

−0.790

***

The country-speciﬁc stock return without the effect of exchange rate (model 5) −0.679

***

−0.740

***

−0.734

***

−0.759

***

−0.700

***

(Part C) Japan

^no

t

−1.944

***

−3.543

***

−0.685

***

−0.795

***

−0.810

***

cu

∗

t

−0.111

***

−0.113

***

−0.110

***

−0.111

***

−0.100

***

The world interest rate (model 1) 0.1100 −0.749

***

−0.498

***

−0.572

***

−0.766

***

−0.717

***

The world stock return with the effect of exchange rate (model 2) 0.0001 −0.954

***

−0.669

***

−0.782

***

−1.087

***

−1.147

***

The country-speciﬁc stock return with the effect of exchange rate (model 3) 0.0072 −0.832

***

−0.592

***

−0.691

***

−0.950

***

−0.988

***

The world stock return without the effect of exchange rate (model 4) −0.748

***

−0.711

***

−0.704

***

−0.746

***

−0.790

***

The country-speciﬁc stock return without the effect of exchange rate (model 5) −0.667

***

−0.608

***

−0.596

***

−0.588

***

−0.621

***

Note: The ADF test is run by regressing ^cu

∗

t

= d

0

cu

∗

t

+

n

i=1

d

i

^cu

∗

t−1

+¡

t

. The reported number is an estimated d

0

. If ca

*

is stationary, d

0

is negative and signiﬁcantly different fromzero.

**

Signiﬁcance at the 5 percent level.

***

Signiﬁcance at the 1 percent level.

3

1

0

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Table 5

Estimation result of the ICA model.

The U.K. Canada Japan

Model 1 Model 2 Model 3 Model 4 Model 5 Model 1 Model 2 Model 3 Model 4 Model 5 Model 1 Model 2 Model 3 Model 4 Model 5

^no

t

0.260 0.435 0.269 0.385 0.235 0.108 0.033 0.114 0.054 0.185 0.710 0.712 0.713 0.714 0.713

[0.079] [0.183] [0.177] [0.182] [0.176] [0.075] [0.105] [0.094] [0.133] [0.151] [0.009] [0.008] [0.008] [0.007] [0.008]

cu

∗

t

0.677 0.589 0.933 0.611 0.941 0.676 0.856 0.668 0.784 0.527 0.605 0.401 0.533 0.122 0.338

[0.391] [0.945] [0.911] [0.945] [0.905] [0.355] [0.503] [0.449] [0.639] [0.717] [0.337] [0.301] [0.310] [0.265] [0.263]

r

∗

t

0.424 0.056 0.017 0.056 0.015 0.124 0.020 0.027 0.033 0.047 0.009 −3.1E−05 −0.002 0.002 −0.009

[0.158] [0.021] [0.013] [0.022] [0.013] [0.060] [0.011] [0.012] [0.015] [0.019] [0.036] [0.000] [0.002] [0.006] [0.007]

^no

t−1

0.476 0.477 0.478 0.477 0.477

[0.010] [0.009] [0.009] [0.008] [0.009]

cu

∗

t−1

0.091 0.141 0.114 0.239 0.200

[0.134] [0.118] [0.118] [0.105] [0.103]

r

∗

t−1

0.013 −1.6E−05 −0.001 −0.001 −0.005

[0.033] [0.000] [0.002] [0.004] [0.005]

^no

t−2

0.236 0.237 0.238 0.235 0.239

[0.008] [0.007] [0.007] [0.006] [0.007]

cu

∗

t−2

0.124 0.180 0.156 0.331 0.328

[0.126] [0.109] [0.110] [0.098] [0.097]

r

∗

t−2

0.012 −3.5E−06 −4.4E−04 −0.002 −0.003

[0.023] [0.000] [0.001] [0.004] [0.003]

¡ 0.3171 0.1383 0.1389 0.1379 0.1374 0.1285 0.0575 0.0663 0.0930 0.1463 0.1100 0.0001 0.0072 0.0086 0.0178

VR 0.698 0.679 1.009 0.691 1.004 0.544 0.795 0.501 0.713 0.385 7.295 7.026 7.179 6.971 7.209

Wald salt 14.943 12.201 5.436 11.123 4.384 8.587 3.232 6.627 4.640 7.240 7092.443 9182.445 8942.681 11167.412 11159.725

p-value 0.002 0.007 0.143 0.011 0.223 0.035 0.357 0.085 0.200 0.065 0.000 0.000 0.000 0.000 0.000

RMSE (×1000) 11.515 17.228 5.923 16.684 5.243 8.925 5.876 9.934 9.036 15.106 51.328 51.636 51.797 51.662 51.646

Note: Numbers are the estimated in Eq. (7). The numbers in square bracket are standard error for the estimated in Eq. (7). ¡ is obtained to minimize the residual sum of squares

1

t=1

[cu

∗

t

− ´ cu

∗

t

]

2

, where cu

∗

t

and ´ cu

∗

t

are actual and predicted current accounts, respectively. The volatility of the predicted current account ( ´ cu

∗

t

) is divided by that of the actual data (ca

*

)

to give the ratios in the “VR” row. The “Wald stat” is the Wald test statistic for the overall ﬁt of the model, and “p-value” refers to this statistic. “RMSE” is root mean squared error (RMSE),

which is deﬁned as

_

1

t=1

[cu

∗

t

− ´ cu

∗

t

]

2

]1 (T is the sample size).

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 311

Fig. 1. The U.K.

rowof Table 5 reports the root mean squared error (RMSE), which is deﬁned as

_

1

t=1

[cu

∗

t

−

´

cu

∗

t

]

2

]1

(T is a sample size). For ease of comparisons, the RMSE is multiplied by 1000 in Table 5. One notable

ﬁnding in Table 5 is that the Wald test rejects the model 1 (benchmark) at 5 percent signiﬁcant level

in all three countries.

I also visually verify the explanatory power of the ﬁve models. Figs. 1–3 show the actual current

account and the predicted current account generated by each ICA model for the three countries. In the

ﬁgures showing each country, the vertical axis has the same scale, in order to facilitate comparisons

between the ﬁve models of each country.

In the following discussion, the performance of each model is considered for each country. Since

it is reasonable to assume that a country-speciﬁc productivity shock appears in its country-speciﬁc

stock return, the following interpretations mainly draw from those of Glick and Rogoff (1995). They

demonstrate the effect of country-speciﬁc productivity shocks on permanent income, and thereby on

current account.

4.2.1. The U.K.

The SIC selects one lag for all the models in order to estimate the VAR system. Models 3 and 5 are

not rejected at a 5 percent signiﬁcant level. These variance ratios are greater than those of model 1

and almost equal to one. These results indicate that the country-speciﬁc shock appearing in its speciﬁc

stock return is an important factor in explaining the movement of the U.K. current account. Glick

312 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

Fig. 2. Canada.

and Rogoff (1995) show that a change in a country’s current account depends on its country-speciﬁc

productivity shock but not on the global shock, since the latter affects all countries equally. Depending

on the model, one possible interpretation for this ﬁnding is that the country-speciﬁc productivity

shock appears in its speciﬁc stock return in the U.K. In other words, models 3 and 5 accommodate the

productivity shock and therefore perform well. Details of their performance can be found in Fig. 1.

Finally, I examine the effect of exchange rate on the U.K. current account. Models 2 and 3 consider

the effect of exchange rate, while models 4 and 5 do not (Fig. 2). The RMSE of model 4 is less than that

of model 2, and the RMSE of model 5 is less than that of model 3. In addition, the variance ratio of

model 4 is closer to unity than that of model 2, while the VR of model 5 is closer to unity than that of

model 3. This implies that the effect of exchange rate is little signiﬁcant in the U.K.

In summary, for the U.K. current account, the above discussion leads us to conclude that model 5

shows the best performance for the U.K., since it includes the country-speciﬁc stock return and ignores

the exchange rate.

4.2.2. Canada

The SIC selects one lag for all the models in order to estimate the VAR system. Models 2–4 are not

rejected at the 5 percent signiﬁcant level. The variance ratios of models 2 and 4 are greater than that

of model 1 and relatively close to unity. In contrast to the modeling of the U.K. data, these variance

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 313

Fig. 3. Japan.

ratios indicate that world stock return is a useful variable in the ICA model of Canada. This may be

due to Canada’s extensive links with the U.S. economy. The world real stock return is computed using

time-varying weights for each country based on the proportion of total G7 GDP that corresponds to

that country’s GDP. The sample mean of the U.S. share is approximately 66 percent, implying that the

shock of U.S. economy appears in the world real stock return sufﬁciently. Since shocks in the U.S. also

have a substantial effect on the Canadian economy and its permanent income, introducing world stock

returns into the ICA model for Canada improves the model performance.

The variance ratio and the smallest RMSE of model 2 suggest the importance of exchange rate for

the ICA model in Canada. This may be due to the openness of the Canadian economy. To measure the

degree of openness, sums of export and import are divided by GDP.

8

These statistics showthat in 2006

the Canadian economy (70.3 percent) was more open that that of the U.K. (60.6) and the Japan (30.9).

4.2.3. Japan

The SIC selects three lags for all the models in order to estimate the VAR system. Therefore, the

size of the matrix in Eq. (7) is 1×9. In contrast to the results with the U.K. and Canada, all the

ICA models perform poorly in Japan. Fig. 3 indicates a structural break around 1980. In December of

that year, the “Foreign Exchange and Foreign Trade Control Law” in Japan was amended, and this had

8

All 2006 yearly data are corrected from the IFS (export 90c; import 98c; GDP; 99b).

314 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

profound effects on Japan’s current account. This amendment allowed Japanese residents to freely

transfer money into foreign countries. Before this amendment, Japanese residents were not allowed

to smooth their consumption by borrowing or lending in international capital markets.

With this consideration in mind, I split the Japanese sample into Q1 1960 to Q4 1980Q4, and Q1

1981 to Q4 2007. Tables 6 and 7 and Fig. 4 report the results of each sample.

Table 6 reports the VAR result, where three and one lags are selected for each period, respectively.

The results presented in Table 7 and Fig. 4 are consistent with the 1980 amendment. In the ﬁrst period,

all ICA models generate more volatile current account series than what actually occurred. This is

due to the fact that the ICA model assumes no obstructions to international transactions, which is

inappropriate during the ﬁrst period, and so causes the model to perform worse during this time.

In the second period, all ICA models are not rejected at the 5 percent signiﬁcance level. The values

of variance ratio and RMSE suggest better performance of models 4 and 5. This implies that the effect

of exchange rates is little signiﬁcant in Japan. Moreover, in terms of variance ratio and RMSE, the

performance of model 5 is better than that of model 4. Like the U.K., a country-speciﬁc shock appears

in its speciﬁc stock return. Thus, model 5 performs best for Q1 1981 to Q4 2007 in Japan.

4.3. Is a stock variable truly important for a current account?

The empirical results show that the ICA model that includes a stock variable performs well.

Nevertheless, the real stock market variable shows poor statistical signiﬁcance in the VAR results

(Tables 3 and 6) for all countries, with the exception of its own autoregressive process and, in some

cases, Japan. One conservative interpretation of these results may be found in volatile stock variables:

stock variables are more volatile than interest rates, which leads the model to predict more volatile

series of the current account. Thus, this variance ratio is better than that of model 1 (the world interest

rate model).

I test this hypothesis formally as follows. First, I generate the series of standard normal random

variables, where the variance corresponds to that of stock variables. The stock variable r

t

in Eq. (4) is

replaced with the random variable. Eqs. (6) and (7) are estimated with ^no, ca

*

, and r

*

of the random

variable. Then I obtain the predicted

´

cu

∗

t

. Finally, I calculate the RMSE with the actual cu

∗

t

and predicted

´

cu

∗

t

and the coefﬁcient of correlation between the random and stock variables. These sequences are

repeated1000times for eachmodel (models 2–5). The higher positive correlationbetweenthe random

and stock variables means that the random variable captures more information on the ﬁrst moment

of the stock variable. If the better performance (small RMSE) is due to the high-positive correlation

between the randomand stock variables, then we should observe a negative relationship between the

RMSE and the coefﬁcient of correlationbetweenthe randomand stock variables. Inother words, if only

the volatility (second moment) of stock variable, but not its ﬁrst moment, is important for accurate

modeling, there is no negative relationship between the RMSE and the coefﬁcient of correlation. I run

the following regression to test this hypothesis:

RMSE = ˛

0

+˛

1

¡

rv,s

+D, (8)

where ¡

rv,s

is the coefﬁcient of correlation between the random and stock variables and D is a distur-

bance term.

Table 8 reports the estimated parameters of Eq. (8), and the numbers in the second line are absolute

t-statistics. To obtain the RMSE and ¡

rv,s

in Eq. (8), I use Japanese data from Q1 1981 through Q4 2007

and I take into account the 1980 amendment. For the other two countries, the complete data sets are

used.

With the exception of models 2 and 3 in Japan, all the estimated ˛

1

s are negative and statistically

signiﬁcant. This conﬂicts with the above hypothesis (˛

1

=0). I conclude that the movement of ﬁrst

moment of the stock variable is important for the dynamics of current account.

The second instance when the VAR parameter can be insigniﬁcant is when the stock variable has a

non-linear effect on net output and the current account. Using the full data set for the U.K. and Canada

and the data set from Q1 1981 to Q4 2007 for Japan, I run the following regression for each modeling

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–

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1

5

Table 6

VAR estimation for the subsample of Japan.

Independent variable Model 1 Model 2 Model 3 Model 4 Model 5

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

^no

t

cu

∗

t

r

∗

t

Sample period: 1960Q1–1980Q4

l^no

t−i

−2.824 −0.008 0.011 −2.811 −0.009 55.962 −2.777 0.001 1.371 −2.800 −0.001 1.016 −2.791 0.001 1.311

(0.000) (0.708) (0.727) (0.000) (0.589) (0.367) (0.000) (0.094) (0.157) (0.000) (0.842) (0.048) (0.000) (0.342) (0.069)

cu

∗

t−i

0.525 0.819 0.094 0.308 0.827 386.340 0.523 0.901 6.018 0.593 0.828 −0.104 0.875 0.878 3.889

(0.000) (0.000) (0.489) (0.000) (0.000) (0.046) (0.000) (0.000) (0.010) (0.000) (0.000) (0.163) (0.000) (0.000) (0.028)

r

∗

t−i

0.693 −0.015 0.721 0.001 1.7E−06 0.211 0.018 −0.010 0.120 0.063 0.004 0.212 −0.044 −0.010 0.207

(0.030) (0.178) (0.000) (0.002) (0.094) (0.460) (0.493) (0.000) (0.257) (0.183) (0.703) (0.004) (0.100) (0.010) (0.002)

R

2

0.926 0.849 0.594 0.930 0.851 0.199 0.919 0.878 0.362 0.922 0.842 0.278 0.923 0.860 0.389

NOB 75 75 75 75 75

Lag (=i) 3 3 3 3 3

max eig 0.973 0.975 0.970 0.972 0.972

min eig 0.219 0.410 0.097 0.344 0.311

Sample period: 1981Q1–2007Q4

l^no

t−i

−0.152 0.023 0.822 −0.221 0.083 565.980 −0.080 0.110 1.668 −0.104 0.075 1.069 −0.080 0.110 1.668

(0.001) (0.986) (0.292) (0.000) (0.879) (0.922) (0.002) (0.776) (0.091) (0.000) (0.901) (0.903) (0.002) (0.776) (0.091)

cu

∗

t−i

−0.074 0.871 0.153 0.083 0.886 1163.014 −0.028 0.900 2.166 −0.058 0.911 3.645 −0.028 0.900 2.166

(0.116) (0.000) (0.060) (0.052) (0.000) (0.026) (0.247) (0.000) (0.293) (0.080) (0.000) (0.069) (0.247) (0.000) (0.293)

r

∗

t−i

0.068 0.042 0.634 −6.6E−05 1.2E−05 −0.069 0.002 0.001 0.215 0.009 −0.002 0.248 0.002 0.001 0.215

(0.354) (0.094) (0.000) (0.049) (0.056) (0.011) (0.777) (0.826) (0.003) (0.127) (0.538) (0.259) (0.777) (0.826) (0.003)

R

2

0.194 0.885 0.480 0.228 0.887 0.203 0.178 0.879 0.200 0.209 0.879 0.136 0.178 0.879 0.200

NOB 106 106 106 105 106

Lag (=i) 1 1 1 1 1

max eig 0.852 0.773 0.761 0.766 0.761

min eig 0.408 0.361 0.130 0.348 0.130

Note: Please refer to the note in Table 3.

3

1

6

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e

s

s

a

n

d

F

i

n

a

n

c

e

2

3

(

2

0

0

9

)

3

0

2

–

3

2

1

Table 7

Estimation results of the ICA model for the subsample of Japan.

Sample period 1960Q1–1980Q4 Sample period 1981Q1–2007Q4

Model 1 Model 2 Model 3 Model 4 Model 5 Model 1 Model 2 Model 3 Model 4 Model 5

^no

t

0.729 0.727 0.732 0.719 0.742 0.180 0.179 0.138 0.063 0.176

[0.008] [0.008] [0.009] [0.011] [0.011] [0.105] [0.105] [0.107] [0.106] [0.100]

cu

∗

t

−0.653 −0.661 −0.114 −0.985 −0.307 1.188 1.191 1.189 0.944 0.991

[0.337] [0.326] [0.345] [0.419] [0.402] [0.721] [0.722] [0.735] [0.725] [0.678]

r

∗

t

0.084 −1.5E−04 −0.001 −0.025 0.024 4.1E−06 4.2E−06 7.3E−06 0.008 3.4E−05

[0.266] [0.000] [0.010] [0.014] [0.013] [0.000] [0.000] [0.000] [0.009] [0.007]

^no

t−1

0.494 0.492 0.500 0.488 0.510

[0.009] [0.009] [0.012] [0.012] [0.013]

cu

∗

t−1

0.496 0.467 0.268 0.447 0.246

[0.194] [0.176] [0.163] [0.234] [0.200]

r

∗

t−1

0.140 −6.4E−05 0.003 −0.012 0.014

[0.142] [0.000] [0.010] [0.008] [0.010]

^no

t−2

0.243 0.246 0.248 0.244 0.258

[0.008] [0.008] [0.009] [0.010] [0.010]

cu

∗

t−2

0.489 0.568 0.398 0.709 0.541

[0.149] [0.147] [0.144] [0.195] [0.165]

r

∗

t−2

−0.146 −3.8E−05 −0.002 −0.013 −0.001

[0.120] [0.000] [0.006] [0.008] [0.007]

¡ 0.2830 0.0001 0.0250 0.0001 0.0281 0.0001 0.0001 0.0001 0.0311 0.0332

VR 13.991 13.932 14.511 13.674 14.619 1.455 1.462 1.460 0.970 1.008

Wald salt 8010.541 9429.910 8682.483 5640.563 6074.567 2.963 2.949 1.819 1.633 3.193

p-value 0.000 0.000 0.000 0.000 0.000 0.397 0.400 0.611 0.652 0.363

RMSE (×1000) 80.841 81.668 80.885 81.611 80.830 3.461 3.496 3.367 1.856 1.744

Note: Please refer to the note in Table 5.

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 317

Fig. 4. The subsample of Japan.

3

1

8

Y

.

K

i

t

a

m

u

r

a

/

R

e

s

e

a

r

c

h

i

n

I

n

t

e

r

n

a

t

i

o

n

a

l

B

u

s

i

n

e

s

s

a

n

d

F

i

n

a

n

c

e

2

3

(

2

0

0

9

)

3

0

2

–

3

2

1

Table 8

Estimation results of Eq. (8).

The U.K. Canada Japan

Model 2 Model 3 Model 4 Model 5 Model 2 Model 3 Model 4 Model 5 Model 2 Model 3 Model 4 Model 5

˛

0

0.019 0.019 0.019 0.019 0.007 0.007 0.012 0.011 0.003 0.003 0.009 0.010

52.433 53.274 50.741 52.680 56.163 58.289 54.006 52.905 103.615 99.499 52.242 55.680

˛

1

−0.043 −0.044 −0.039 −0.041 −0.009 −0.009 −0.013 −0.010 0.002 0.002 −0.013 −0.016

8.921 9.289 7.608 8.368 5.190 5.231 4.555 3.479 8.435 7.415 6.830 8.859

R

2

0.074 0.079 0.055 0.066 0.026 0.027 0.020 0.012 0.066 0.052 0.045 0.073

NOB 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000

Note: The ordinary least square (OLS) estimator is reported. The number in the second line is an absolute t-statistic. “NOB” is the number of observations.

Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 319

Table 9

Estimation results of Eqs. (9) and (10).

Independent variable Model 2 Model 3 Model 4 Model 5

^no

t

cu

∗

t

^no

t

cu

∗

t

^no

t

cu

∗

t

^no

t

cu

∗

t

(Part A) The U.K.

^no

t−1

−0.322 −0.077 −0.312 −0.085 −0.328 −0.078 −0.313 −0.084

(0.000) (0.121) (0.000) (0.102) (0.000) (0.119) (0.000) (0.105)

cu

∗

t−1

−0.002 0.924 0.008 0.918 0.001 0.927 0.008 0.920

(0.477) (0.000) (0.413) (0.000) (0.487) (0.000) (0.406) (0.000)

r

∗

t−1

0.014 −0.001 0.003 −0.003 0.017 0.003 0.009 0.001

(0.058) (0.450) (0.374) (0.351) (0.034) (0.357) (0.165) (0.465)

Dum×r

∗

t−1

−0.014 −0.005 −0.009 0.004 −0.017 −0.011 −0.016 −0.002

(0.098) (0.295) (0.195) (0.344) (0.061) (0.127) (0.060) (0.436)

R

2

0.119 0.824 0.116 0.822 0.123 0.825 0.123 0.822

NOB 185 185 185 185 185 185 185 185

(Part B) Canada

^no

t−1

−0.225 −0.072 −0.253 −0.083 −0.218 −0.070 −0.266 −0.101

(0.001) (0.122) (0.000) (0.092) (0.001) (0.130) (0.000) (0.054)

cu

∗

t−1

−0.071 0.892 −0.057 0.895 −0.064 0.896 −0.054 0.900

(0.033) (0.000) (0.070) (0.000) (0.046) (0.000) (0.082) (0.000)

r

∗

t−1

−0.008 −0.013 −0.019 −0.004 −0.013 −0.015 −0.025 −0.019

(0.194) (0.055) (0.094) (0.378) (0.087) (0.049) (0.034) (0.059)

Dum×r

∗

t−1

0.019 0.016 0.019 0.007 0.028 0.016 0.029 0.024

(0.037) (0.044) (0.111) (0.308) (0.007) (0.056) (0.032) (0.041)

R

2

0.108 0.795 0.091 0.792 0.124 0.795 0.100 0.795

NOB 185 185 185 185 185 185 185 185

(Part C) Japan

^no

t−1

−0.192 0.038 −0.192 0.029 −0.192 0.034 −0.188 0.033

(0.024) (0.242) (0.024) (0.296) (0.022) (0.271) (0.027) (0.278)

cu

∗

t−1

0.005 0.889 0.001 0.886 −0.025 0.902 −0.015 0.925

(0.472) (0.000) (0.492) (0.000) (0.352) (0.000) (0.407) (0.000)

r

∗

t−1

7.6E−06 2.9E−05 1.0E−05 2.8E−05 0.007 0.003 0.003 −0.005

(0.393) (0.033) (0.363) (0.039) (0.225) (0.298) (0.372) (0.136)

Dum×r

∗

t−1

−1.5E−05 −1.4E−05 −1.6E−05 −1.1E−05 3.3E−04 0.001 0.002 0.003

(0.316) (0.216) (0.303) (0.271) (0.487) (0.465) (0.399) (0.316)

R

2

0.039 0.865 0.039 0.864 0.058 0.858 0.048 0.857

NOB 106 106 105 105 106 106 105 105

Note: The table reports the OLS estimator of Eqs. (9) and (10) (for models 2–5). The number in parenthesis is a p-value for

t-statistics. “NOB” is the number of observations.

of the stock variable:

^nc

t

= 0

11

^nc

t−1

+0

12

cu

∗

t−1

+0

13

r

∗

t−1

+Dum0

14

r

∗

t−1

+q

1,t

, (9)

cu

∗

t

= 0

21

^nc

t−1

+0

22

cu

∗

t−1

+0

23

r

∗

t−1

+Dum0

24

r

∗

t−1

+q

2,t

, (10)

where q is a disturbance term. “Dum” is a dummy variable that takes a value of one when the stock

variable r

∗

t−1

is greater thantwostandarderror bands; otherwise, its value is zero. This assumes that the

large movement in the stock variable does affect a current account differently fromits all other change.

Table 9 reports the estimated parameters for each modeling of the stock variable (models 2–5).

The number in parenthesis is a p-value for t-statistic. In some cases for the U.K. and Canada, I obtain

signiﬁcant parameters (at the 5 or 10 percent level) for both large changes (0

14

and 0

24

) and all other

change (0

13

and 0

23

) in the stock variable, although this is not the case in Japan. In that country, all

other change inthe stock variable (0

13

and 0

23

) are statistically signiﬁcant inthe ca

*

equationof models

2 and 3. These ﬁndings may suggest that the stock variable has a non-linear effect on net output and

on the current account.

320 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

Another instance when the VAR parameter can be insigniﬁcant is that a stock adjustment has dif-

ferent effects on the current account from each other. According to the permanent income model

of consumption, when a positive stock adjustment is related to a change in permanent income,

the adjustment causes a current account deﬁcit if permanent income rises more than current

income. When a rise in stock price increases only current income, agents save a part of it and

a country runs a current account surplus. If this scenario is valid, I should decompose a stock

variable into permanent and transitory components, depending on whether a stock price adjust-

ment reﬂects a change in permanent income or not. This should be investigated further in future

studies.

In summary, the results of Tables 8 and 9 suggest that models that take into consideration the

stock variable perform well not because of particularities for speciﬁc countries, but because the stock

variable explains movement in the current account.

5. Conclusion

This study empirically examines the explanatory power of the stock return in the intertemporal

approach to a current account (ICA).

The empirical result of this paper shows that the ICA model performs well for all of the sample

countries oncethestockvariableis takenintoconsideration. Onepossibleinterpretationfor this ﬁnding

is that an agent optimally smoothes consumption based on stock market information. In other words,

since stockreturnis aninformative variable for permanent income, the stockmarket model cancapture

the consumption behavior of an agent and the dynamics of the current account. In addition, according

to the permanent model of consumption, even when a change in stock price affects current income but

not permanent income, this income change may cause movement of the current account as a result of

agents’ actions to smooth consumption.

This study leaves unresolved the question of why the stock variable shows weak explanatory power

in the VAR system. Future research should therefore examine several different effects of the stock

variable on current accounts.

Acknowledgement

I would like to thank an anonymous referee for constructive comments and invaluable suggestions

that have substantially improved the paper. Naturally, all errors are my own.

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Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321

303

versions of the ICA have been tested empirically in Sheffrin and Woo (1990), Otto (1992), and Ghosh (1995). These studies assume that the country in consideration is small, and they adopt present value tests developed by Campbell and Shiller (1987). However the results from these simple models are inconsistent with the small country assumption: the ﬁt of the ICA is better in some larger countries than in smaller ones.2 Thus, the explanatory power of the ICA is insufﬁcient in some cases, showing the need to improve the model. Previous studies have used a representative agent who is forward-looking and can borrow and lend at a constant world interest rate. However, the current account is likely to be affected by changes in the interest rate, and these studies fail to take those effects into consideration. Sachs (1982) argues that the current account can be separated into two components: a consumption-smoothing motive and a consumption-tilting motive. The consumption-tilting motive makes a country tilt its consumption toward the present or the future, depending on the magnitude of the world interest rate in relation to its subjective discount rate. In other words, if the interest rate is higher than the discount rate, the country saves in the international capital market. This indicates the possibility that the change in the world interest rate induces a change in consumption. This leads, in turn, to a change in the current account. Bergin and Sheffrin (2000) succeeded in accommodating a time-varying interest rate into their empirical model. They ﬁnd that taking both the interest rate and exchange rate into consideration improves the ﬁt of the ICA model. Drawing on the work of Bergin and Sheffrin (2000), I focus on the role of stock returns in the ICA. As mentioned after, the ICA model performs well when stock market returns are taken into consideration. This ﬁnding is consistent with the permanent income hypothesis: due to its wealth and leading effects mentioned in the following section, a stock price adjustment causes or signals a change in permanent income. In the permanent income model of consumption, the change in permanent income affects the country’s consumption, amount of savings, and therefore net foreign asset position. Moreover, the adjustment leads to movement in the current account even when a stock price adjustment is unrelated to changes in permanent income. According to the permanent income model of consumption, when a stock price adjustment temporarily increases current income, agents save a part of any transitory increase in income in order to smooth their intertemporal consumption. This paper is organized as follows. In Section 2, I summarize the theoretical research on impacts of stock market movements on the current account and the economic model. Section 3 describes the data used in empirical analysis. Section 4 presents the empirical results for three nations: the U.K., Canada, and Japan. The ICA has already been shown to perform poorly in the case of the U.K., Canada (Sheffrin and Woo, 1990), and Japan (Ghosh, 1995). I show here that when stock market returns are considered, the results of the model differ from those of previous studies. Finally, Section 5 concludes. 2. The theory and model 2.1. Impact of a stock market on a current account: a theoretical background The channel through which stock price adjustments affect current accounts is attributed to a country’s consumption behavior. A stock price adjustment affecting consumption may affect the total amount of country savings, and therefore the net foreign assets position. The effects of stock price on consumption are divided into three categories: wealth, uncertainty, and leading indicator effects (see Apergis and Miller, 2006). Using the permanent income hypothesis, Hall (1978) argues that a stock price adjustment causes a change in permanent income – the so-called wealth effect – and thus a change in consumption. Glick and Rogoff (1995) show that a positive permanent country-speciﬁc productivity shock induces investment and leads to a higher future capital stock, thereby raising permanent income. If new permanent income surpasses current income, the current account enters a deﬁcit, since a country’s consumption is based on foreign borrowing. A purely transitory positive shock results in a current account surplus,

2 Otto (1992) empirically investigates the ﬁt of the ICA in the U.S. and Canada and his result concludes that the ﬁt in the U.S. is much better than one in Canada.

Replacing the world interest rate in Bergin and Sheffrin (2000) with several stock returns. allowing us to observe the channel through which stock price adjustments affect the current account. We do this using an approach different from that of Mercereau (2003b). / 0 < a < 1. Kitamura / Research in International Business and Finance 23 (2009) 302–321 since agents save a part of their transitory increase of income. Thus. a permanent shock in net output may appear in the stock market. This is due to the fact that a current account is a consequence of agents’ optimal consumption behavior and should therefore contain all available information. whereby current stock price changes predict future movements in income. It is plausible that these country-speciﬁc shocks appear in stock markets. As mentioned above. Yt − (CTt + Pt CNt ) − It − Gt + rt Bt−1 = Bt − Bt−1 . B–S assumes a representative agent in a small open economy. including stocks. This adjustment in durable stock leads to a change in aggregated consumption spending and a temporary movement in the current account.S. The model The model used in the present study draws heavily from the work of Bergin and Sheffrin (2000) (hereafter B–S). where a 1−a (CTt CNt ) 1− (2) U(CTt. This is due to the fact that the time-varying world interest rate captures external shocks in borrowing and lending in the international market. leading to a temporary movement in the current account. Bergin and Sheffrin (2000) develop a model of ICA that incorporates time-varying interest rates.2. which reduces expenditures on durable goods (Romer. I perform present value tests of ICA and investigate which factor – the world interest rate or stock price – plays the more dominant role in the movement of the current account.S. CNt. is a somewhat good predictor for future stock performance in the U. The main implication of this model is that a current account may help to predict future stock market performance. the latter ﬁnds the Granger causality from current account to future stock performance. The model is summarized by the following set of equations: ∞ max Et s=t ˇs−t U(CTs . the model can reproduce agents’ intertemporal consumption smoothing behavior. . Investor uncertainty changes the path of durable consumption. He argues that a permanent shock in net output causes durable stock to adjust to new levels that are optimal for the new net output. = 1. CNs ) (1) s. In summary. Therefore. including current and future stock market performance. in relation to durable consumption. Mercereau (2003b) runs the Granger causality test and ﬁnds evidence that the current account of the U. we can evaluate the relationship between the stock market and current account.t. which improves model performance beyond those of previous studies. ˙¸ Iscan (2002) develops a present value model of ICA that incorporates durable consumption. The second effect is investor uncertainty from stock price decreases. Based on the model of Mercereau (2003a). it is plausible to consider several channels through which stock price adjustment affects consumption and therefore a current account. Mercereau (2003a) develops a current account model that permits an arbitrary number of risky assets. to determine an optimal portfolio. 2. this paper introduces a country-speciﬁc deﬁnition of the stock market variable: the difference between the country and world real stock returns. This observation is potentially related to the theoretical ˙¸ background of Iscan (2002). 1990). Since the model developed by Bergin and Sheffrin (2000) enables us to implement a direct test for the present value model of ICA. In contrast. > 0.304 Y. ) = 1− . In addition. Poterba and Samwick (1995) propose a leading indicator effect.

CNt = real consumption of a nontraded goods. ∗ rt = rt + (3) pt + cons. Following B–S. if the rate rt is expected to rise temporarily over its average. Following B–S. This study empirically examines the ICA model in the form of Eq. (6). This expression allows us to see the ICA as a present ∗ discount model. NO is net output (net cash ﬂow) deﬁned as NOt = Yt − It − Gt . consumption smoothing behavior increases the current account. Bt = stock of assets (equity). rt = real stock return. Yt = real output level. . It is easy to generalize the form of Eq. The current account is deﬁned as CAt ≡ NOt − Ct . The lag length of VAR is determined according to the Schwartz information criterion (SIC). Assuming that the real return and consumption are jointly homoscedastic and lognormal. (5) indicates that. so the constant term is ignored. B–S obtains the following equation: ∞ −Et i=1 ∗ ˇi [ not+i − rt+i ] = not − ct (≡ ca∗ ). It = real investment. (5). Pt = the relative price of home nontraded goods in terms of traded goods. ∗ where Z t ≡ [ not . a = the share of traded goods in the ﬁnal private consumption. Using log linearization. the inﬁnite sum of Eq. pp. which reﬂects both the real interest rate and the relative price of nontraded goods (real exchange rate). To obtain the proxies for the expected values. (6) to incorporate higher orders of the VAR in the ﬁrst order form (Sargent. B–S considers traded and nontraded goods. ca∗ . (5) is expressed as follows: −1 ca∗ = −(G1 − G2 )ˇA(I − ˇA) t not ca∗ t ∗ rt = no ca r not ca∗ t ∗ rt . t (5) where ct = ln Ct and not = ln NOt − ln NOt−1 . In Eq. Assuming ≥ 0. I adopt present value tests developed by Campbell and Shiller (1987) and estimate a vector auto-regressive (VAR) system as follows: not ca∗ t ∗ rt = a11 a21 a31 a12 a22 a32 a13 a23 a33 not−1 ca∗ t−1 ∗ rt−1 + ε1t ε2t ε3t . and the approximation ln(1 + r) ≈ r is used. showing that the optimal consumption proﬁle in Eq. Following B-S. (4) 1− (1 − a) where = 1/ . (4) are assumed to be constant. I label this transformed representation of the current account as ca* (≡not − ct ). I set the lag length of VAR to a value between 1 and 3. Ut is the dist turbance matrix of εs. (3) is inﬂuenced by ∗ the consumption-based interest rate rt . (5). (5). rt ] and A is the transition matrix of the VAR and Et (Zt+i ) = Ai Zt .5. The variances and covariances in Eq. a present current account ca* is expressed with discount values of a future change in ∗ net output ( no) and a future interest rate (rt ). I ﬁx this parameter to 0. I need some proxies for the expected values that Eq. ˇ = subjective discount factor3 .. Eq. (6) More compactly: Z t = AZ t−1 + U t . pt+1 = ln Pt+1 − ln Pt . 1/ = the elasticity of intertemporal substitution. With Eq. 272–273). Gt = real government spending. To test the restriction of Eq. ct+1 = ln Ct+1 − ln Ct (Ct = CTt + Pt CNt ). and the right hand side of (5) is similar to the deﬁnition of the current account. 1987. (7) 3 4 The discount factor ˇ is set to 0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 305 CTt = real consumption of a traded good.97 in this study.Y. focusing on the relationship between stock returns and the current account. except that its components are in log terms. All variables are demeaned. the Euler equation is written in log form: ∗ Et [ ct+1 ] = Et [rt+1 ].4 Maximizing (1) subjected to (2) yields the Euler equation. (5) contains.

The consumption price index for industrial countries.5 3. I label this model as model 1 (the benchmark). which are tested in the following section. are also available upon request. where V is the variance-covariance matrix of the parameters of VAR. such as the consumption based interest rate in Eq. which minimize the Wald statistic. which minimize the Wald statistic. I adopt a weighted average of G7 consumption price indices to obtain an industrial one. NO (the net output) = 99b − (93e + 93i) − 91f.K. T 2 degrees of freedom. I then compute the world and countryspeciﬁc real stock returns (models 4 and 5. Kitamura / Research in International Business and Finance 23 (2009) 302–321 IFS series 96f 93e+93i 91f 62 60b 99b 64 nec ae 99z 99bvr Private consumption Investment Government expenditure Stock index Money market rates Gross domestic product Price index Effective nominal exchange rate Nominal exchange rate Population GDP deﬂator Note: All data are from the International Financial Statistics (online). stock price index data from Q2 1999. where G1 = [1 0 0] and G2 = [0 0 1]. is available from Q1 1968. so I replace the missing data using a corrected FTSE index from Yahoo Finance. (7). and Japan. Except for the U. The residual sum of squares (RSS) is t deﬁned as [ca∗ − ca∗ ] . Let ca∗ t 5 B-S adopts the later method to obtain the parameter . Under the null hypothesis. [ no ca r ] = [0 1 0] holds in Eq. Table 2 summarizes the ﬁve models. this calculation assigns time-varying weights to each country based on the proportion of total G7 GDP that corresponds to that country’s GDP.306 Table 1 Data used in this study. all data are from the International Financial Statistics (IFS). The results of s. The IFS does not provide U.. (4). respectively. I consider the ﬁve ﬁnancial variables for rt in Eq. In addition. The other data series are the same as those in B–S. When rt in Eq. which has a chi-squared distribution with three and ca∗ be actual and predicted current accounts. stock price. ignoring the effects of exchange rate [a = 1 in Eq. Readers can ﬁnd the details in Section 2 of B–S. (4). which B–S uses to calculate the real exchange rate. All series are seasonally adjusted at annual rates. (7) than s. Data I test Eq. I calculate the ratio of the IFS stock index to the FTSE in Q1 1999 and multiply the series of FTSE index by this ratio. ca* (current account) = ln NO − ln 96f.K. Canada. I calculate the country-speciﬁc deﬁnition of the stock market variable as the difference between the country and the world real stock returns (model 3). A comparison will reveal which is more informative for consumption smoothing. . This computation technique also provides the world real stock return (model 2). Details of the data are shown in Table 1. respectively). Details for data creation. This method gives us more accurate t t t=1 prediction of Eq. I obtain the net output (not ) and current account (ca∗ ) for each country. For all three countries. To adjust the series of FTSE to IFS stock index. (4)]. Let equal [ no ca r ] and ˜ be the difference between the actual and [0 1 0]. are omitted because this paper adopts the same method of B–S. the data cover the period from Q1 1960 to Q4 2007.K. (4) is the world real interest rate. I adopt the B–S method to compute ∗ the world real interest rate. I searched s to minimize the RSS. In order to t ∗ compare the model performance. Applying the same method. (7) using quarterly data from three countries: the U. Then ˜ ((∂ /∂A)V(∂ /∂A) )−1 ˜ is the Wald statistic. Category Y. Alternatively.

More detail can be found in Section 2 of Bergin and Sheffrin (2000).b). the ADF test rejects the presence of a unit root at least 5 percent signiﬁcant level for all numbers of lags. I also check the assumption that variables in the VAR.6 The “max (min) eig” reports the maximum (minimum) modulus of eigenvalues of the coefﬁcient matrix A in Eq. 1994). (4) The world interest rate The world stock return Country-speciﬁc stock return The world stock return Country-speciﬁc stock return Note: The world interest rate (stock return) is a weighted average of G7 real money market rates (real stock return) using timevarying weights for each country based on the proportion of total G7 GDP that corresponds to that country’s GDP. no. (7) and some statistics for evaluating model performance.3. Because all series are demeaned. The “Wald stat” is the Wald test statistic for the overall ﬁt of the model and “p-value” relates to this statistic. The last 6 The poor statistical signiﬁcance of stock variables may imply no validity of stock variables for the ICA model. (4)] Yes [a = 0. I perform the augmented Dickey–Fuller (ADF) unit-root test for a range of lags 1-5. Model 1 suggests that consumption reacts to changes in the world interest rate calculated from the money market interest rates of G7 countries and the real exchange rate. which take into consideration the effects of stock returns. (6).2. (4)] No [a = 1 in Eq. If the ratio is equal to one.1. Results 4. Table 4 provides the ADF unit-root test7 results for each country during the sample period. (4)] 307 Interest rate/stock variable rt in Eq. they ﬂuctuate around a level of zero without apparent trend in the sample. The numbers in square brackets are standard errors for each estimated factor of . (7)) is analyzed using the data explained in the previous section. The ﬁrst model is model 1. This variance ratio is used as an index to see whether each model captures the actual change in a current account. The each empirical result of the ICA is summarized in Table 5. the ICA model (Eq. (4)] No [a = 1 in Eq. If the other four models (models 2–5) perform better than model 1. 4. and the ﬁnancial variables (r* s). This issue is discussed in Section 4. in which the null is that all the parameters of each independent variable are zero. are stationary. developed by B–S. Model 1 is a benchmark for the other four. then the effect of the stock return is a more important factor than the interest rate for the ICA model. . Table 3 reports the sums of estimated parameters of each independent variable for one dependent variable. Model Model 1 (benchmark) Model 2 Model 3 Model 4 Model 5 The effect of exchange rate Yes [a = 0. for all variables. The numbers in parenthesis are the p-values for the chi-squared test (the Granger causality test). 4. A value of is ˆ obtained that minimizes the RSS. ∗ To test Eq.Y. The country-speciﬁc stock return is the difference between the country and the world real stock returns. The estimation results of VAR are shown in Table 3.5 in Eq. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Table 2 Summary of the ﬁve models. (4)] Yes [a = 0. Table 3 shows that the modulus of all eigenvalues lies inside the unit circle. This result is consistent with Mercereau (2003a. 7 I do not include a time trend or a constant in the ADF regression. Table 5 reports the estimated in Eq. then the model perfectly captures the volatility of the actual current account. For all variables. ca* and rt ) in the VAR model and obtain the coefﬁcient matrix A for each model. VAR estimation In this section. it is necessary to estimate three variables ( no. Empirical results Following VAR estimation.5 in Eq. This result suggests that all variables can be treated as stationary. (7).5 in Eq. ca* . I calculate the current account predicted by each ICA model using an estimated VAR coefﬁcient matrix. The volatility of the predicted current account (c a∗ ) is normalized to the volatility of the actual current account (ca* ) in the “VR” row of Table 5. indicating that the VAR system satisﬁes its stability condition (see Hamilton.

189 0.084 (0.000) 0.093) 0.953 0.084 (0.479) 0.000) −0.197 0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 r∗ t−i R2 NOB Lag (=i) max eig min eig (Part C) Japan not−i ca∗ t−i −0.008 (0.000) 1.031) −0.792 −0.006 (0.822 ∗ rt Model 5 ca∗ t −0.896 (0.529) 0.794 −0.294) 0.077 −0.128 0.015 (0.032 (0.234 (0.907 (0.671) 0.190) 0.019) 0.392 0.327) 0.080 (0.002 (0.698) 0.266) 0.000) 0.881 (0.037) 0.016 (0.312 (0.822 ∗ rt Model 3 ca∗ t −0.004 (0.176) 0.313 Note: The table reports the sums of estimated parameters of each independent variable and the numbers in parenthesis are the p-values for the chi-squared test (the Granger causality test). .326 (0.084 (0.188) 0.246) 0.312 (0.246 (0.631) 5.7E−04 (0.957 0.910 (0.365 (0.920 0.K.822 ∗ rt r∗ t−i R2 NOB Lag (=i) max eig min eig (Part B) Canada not−I ca∗ t−i −0.245) 0.246 (0.119 (0.904) 0.000) 0.900 0.054) −0.063 (0.244 (0.139) −0.007) 2.325) 0.000) −0.920 (0.008) 0.327 0.309 (0.155 −0.354 (0.625 (0.079 (0.004 (0.104) 0.252 −0.890 (0.112 185 1 0.897 (0.081 not −0.000) −1.225) 0.626 (0.149 (0.000) −2.000) 0.879 0.223) 0.792 −1.000) −0.325 (0.833 (0.920 0.690) 0.619) 0.329) 0.019) 1.937) −0.000) −9.690 (0.000) 0.339 not −0.065 (0.8E−06 (0.057 (0.111 185 1 0.849 0.201) 0.255 −0.104) 0.162) −0.412 0.121 (0.000) −0.543) 0.844 0.846 0.547 (0.087 0.085 (0.396 (0.004 (0.083 185 1 0.000) 0.025 (0. “NOB” is the number of observations and “Lag” is a lag length for the VAR system.000) −0.631 (0.361 (0.340 (0.848 0.077 ca∗ t −0.000) −0.138 0.966) 0.002) −2.469 1.095 185 1 0.240) 0.923 (0.000) 0.082 (0.902 0.000) −0.083 (0.000) 0.792 −0.000) −0.923 (0.236 −0.000) 0.625 (0.000) 0.000) −0.617 (0.002) −2.730) 346.707 (0.093) 1.896 (0.923 (0.917 0.624 (0.920 0.158 (0.899 0.005 (0.033 (0.173 0.986) 0.893) −0.880 0.130 0.507 (0.919 0.895) 0.862 (0.Table 3 VAR estimation.878 0.092 185 1 0.227 −0.000) 0.259) 0.003 (0.000) −0.222 (0.085 (0. The “max (min) eig” reports the maximum (minimum) modulus of eigenvalues of the coefﬁcient matrix in Eq.329 (0.836) 0. The null is that all the parameters of each independent variable are zero.542 (0.955 min eig 0.385 (0.751) 0.604 (0.038) 1.676) 0.000) 0.209) 0.267 (0.003) 0.005) 0.000) −0.188 (0.823 ∗ rt Model 4 ca∗ t −0.256 (0.013 (0.008 (0.467) 0.955 0.017 (0.083 185 1 0.001) −0.895 (0.445 (0.243 (0.020 Y.004 (0.004 (0.126) 0. which is determined by the Schwartz information criterion.000) −0.593 (0.668 (0.058 r∗ t−i −2.112 185 1 0.012 (0.784) 0.010) −2.007 (0.059 (0.330 (0.391) 0.154) 0.251) 0.241 (0.000) 0.001) 0.316 (0.000) −2.122 −0.015 (0.087 (0.907) 0.429 (0.005 (0.827) 0.956 0.093 (0.077 (0.146 (0.112 185 1 0.108 185 1 0.920 (0.167 (0.000) 0.018) 77.120) 0.5E−04 (0.613) 0.571) 0.762) 0.000) −0.878 0.203) 0.328 (0.877 (0.091 (0.139) 0.230 −0.361) 0.035 (0.004 (0.842 0.065 (0.240 −0.002 (0.000) 0.115) 0.815) 0.001 (0.000) −0.248 (0.004 (0.900 0.192 R2 NOB 183 183 182 183 182 Lag (=i) 3 3 3 3 3 max eig 0.083 185 1 0.874 0.584) 0.020) 0.418 0.906) −0.548) 0. (6).352 (0.000) −0.000) −0.000) 0.003 (0.000) −0.323 (0.240 (0.018 (0.527) 0.137) 0. not−i ca∗ t−i 308 Model 2 ca∗ t −0.172) 0.108) 0.172) 0.025 1.129) −0.900 0.958 (0.510) 0.141) −0.330 (0.009 (0.002 (0.214) 0.000) 0.492) 0.511) 0.875) 0.7E−05 (0.000) −0.117 (0.885 (0.897 (0.005 (0.418) −0.000) −0.056 (0.792 0.001 (0.224) 0.338 not −0. Independent variable Model 1 not (Part A) The U.193 (0.005 (0.008 (0.684 (0.154 (0.230) 0.176 (0.001 (0.824 ∗ rt not −0.000) 0.001) −0.

227*** −0.118*** −0.0072 −0.790*** −0.152*** −0.679*** −1.127** −0.942*** −0.154*** −0. Signiﬁcance at the 5 percent level.669*** −0.688*** −1.100*** −0.147*** −0.759*** −1.121*** −0.667*** −3.094*** −0.113*** −0.725*** −0.0663 −0.392*** −0.608*** −0.749*** −0.621*** ca∗ = d0 ca∗ + t t n i=1 di ca∗ + t−1 t.746*** −0.413*** −0.810*** −0.543*** −0.790*** −1.1285 0.691*** −0.0575 0.110*** −0.194*** −0.695*** −0. Variables (in Eq.656*** −0.588*** −0.704*** −1.728*** −0.746*** −0.748*** −0.704*** −0.596*** −0.106*** −0.498*** −0.130*** 5 Y.903*** −0.132** −0.331*** −0.704*** −0.748*** −0.235*** −0.766*** −1.944*** −0.025*** −0.782*** −0.664*** −0.701*** −0.832 *** −0.239*** −0. The reported number is an estimated d0 .746*** −1.082** 0.458*** −0. (4)) Lag length of the ADF test l (Part A) The U.685*** −0.932*** 3 −1.711*** −0.210*** −0.1389 −0.086*** −0.107*** −0.104*** −1.795*** −0.111*** −0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 −1. 309 .762*** −0.716*** −0.113*** 0.711*** −0. Signiﬁcance at the 1 percent level.1383 0.091** −0.Table 4 Unit root tests.098** −0.773*** −0.290*** −0.734*** −1.K.988*** −0.023*** 4 −1.717*** −1.954*** −0.1100 0.592*** −0.128**** −0.716*** −0.700*** −1.093*** −0.950*** −0. not ca∗ t The world interest rate (model 1) The world stock return with the effect of exchange rate (model 2) The country-speciﬁc stock return with the effect of exchange rate (model 3) The world stock return without the effect of exchange rate (model 4) The country-speciﬁc stock return without the effect of exchange rate (model 5) (Part B) Canada not ca∗ t The world interest rate (model 1) The world stock return with the effect of exchange rate (model 2) The country-speciﬁc stock return with the effect of exchange rate (model 3) The world stock return without the effect of exchange rate (model 4) The country-speciﬁc stock return without the effect of exchange rate (model 5) (Part C) Japan not ca∗ t The world interest rate (model 1) The world stock return with the effect of exchange rate (model 2) The country-speciﬁc stock return with the effect of exchange rate (model 3) The world stock return without the effect of exchange rate (model 4) The country-speciﬁc stock return without the effect of exchange rate (model 5) Note: The ADF test is run by regressing ** *** 2 −1.740*** −1.345*** −0.794*** −1. If ca* is stationary.790*** −0.910*** −1.746*** −1.0001 0.147*** −0.108*** −0.433*** −0.310*** −0. d0 is negative and signiﬁcantly different from zero.711*** −0.087*** −0.234*** −0.572*** −0.111*** 0.3171 0.637*** −0.748*** −0.720*** −0.

934 0.640 0.589 [0.008] 0.017 [0.151] 0.009] 0.357 5.503] 0.945] 0.876 0.646 Y.085 9.026 9182.079] 0. (7).1379 0. which is deﬁned as [ca∗ − ca∗ ] /T (T is the sample size). Model 1 not ca∗ t rt∗ not−1 ca∗ t−1 ∗ rt−1 Canada Model 2 0.401 [0.0178 7.676 [0.003] 0.007] 0. respectively.141 [0.905] 0.015 [0.235 [0.056 [0.002 [0.236 [0.060] Model 2 0.0086 6.6E−05 [0.000 51.098] −0.1E−05 [0.006] 0.200 9.004] 0.108 [0.035 8.008] 0.009 5.515 2 0.941 [0.103] −0.5E−06 [0.477 [0.201 0.002 [0.923 0.639] 0.239 [0.943 0.122 [0.126] 0.713 [0.183] 0.012 [0.007] 0.124 [0.605 [0.784 [0.075] 0.856 [0.007] 0.033 [0.679 12.114 [0.662 Model 5 0.105] 0.627 0.182] 0.008] 0.002 11. Kitamura / Research in International Business and Finance 23 (2009) 302–321 0.477 [0.K. The volatility of the predicted current account (ca∗ ) is divided by that of the actual data (ca* ) t t t t t T t=1 to give the ratios in the “VR” row.424 [0.011 16. where ca∗ and ca∗ are actual and predicted current accounts.443 0.717] 0.065 15.1374 1.009 [0.445 0.007] 0.000] 0.133] 0.180 [0.004 4.945] 0.000] 0.684 0.008] 0.020 [0.925 0.033 [0.668 [0.004] 0.681 0.054 [0.008] 0.501 6.544 8.036 0.0072 7.331 [0.533 [0.177] 0.412 0.097] −0. t t 2 .265] 0.123 0.328 [0.698 14.158] not−2 ca∗ t−2 ∗ rt−2 VR Wald salt p-value RMSE (×1000) T t=1 0.710 [0.1285 0.328 Model 2 0.263] −0. is obtained to minimize the residual sum of squares [ca∗ − ca∗ ] .435 [0.094] 0.527 [0.009] 0.235 [0.714 [0.476 [0.449] 0.911] 0.185 [0.022] Model 5 0.109] −3.355] 0.240 0.223 5. The “Wald stat” is the Wald test statistic for the overall ﬁt of the model.156 [0.036] 0.118] −1.385 7.677 [0.712 [0.006] 0.310 Table 5 Estimation result of the ICA model.3171 0.691 11.010] 0.021] Model 3 0. and “p-value” refers to this statistic.007] 0.091 [0.033] 0.384 0.134] 0.124 [0.118] −0.001 [0.176] 0.237 [0.391] 0.105] −0. (7).007 17.000 51.713 4.295 7092.238 [0.001 [0.000 51.012] Model 4 0.002] 0.795 3.056 [0.209 11159.725 0.0575 0.243 0.013] Model 1 0.114 [0.013] Model 4 0.228 0.027 [0.269 [0.200 [0.003 [0.000] 0.0930 0.1389 1.179 8942.0663 0.477 [0.000 51.000 51.005] 0.009] 0.587 0.001] 0.009 [0.478 [0.002] 0.002 [0.713 [0.1383 0.110] −4.310] −0.301] −3.047 [0. “RMSE” is root mean squared error (RMSE).797 Model 4 0.019] Japan Model 1 0.338 [0.143 5.005 [0.1100 7.260 [0.011] Model 3 0.023] 0.385 [0.611 [0.636 Model 3 0.232 0.933 [0.106 Note: Numbers are the estimated in Eq.337] 0. The U.1463 0. The numbers in square bracket are standard error for the estimated in Eq.0001 7.015] Model 5 0.971 11167.239 [0.4E−04 [0.436 0.009] 0.013 [0.

the RMSE is multiplied by 1000 in Table 5.K. These results indicate that the country-speciﬁc shock appearing in its speciﬁc stock return is an important factor in explaining the movement of the U.2. In the following discussion. 4. 1–3 show the actual current account and the predicted current account generated by each ICA model for the three countries.Y. which is deﬁned as [ca∗ − ca∗ ] /T t t t=1 (T is a sample size). The SIC selects one lag for all the models in order to estimate the VAR system. Models 3 and 5 are not rejected at a 5 percent signiﬁcant level. Glick T 2 . the performance of each model is considered for each country. in order to facilitate comparisons between the ﬁve models of each country. These variance ratios are greater than those of model 1 and almost equal to one. The U. Figs. They demonstrate the effect of country-speciﬁc productivity shocks on permanent income. The U.K. I also visually verify the explanatory power of the ﬁve models. One notable ﬁnding in Table 5 is that the Wald test rejects the model 1 (benchmark) at 5 percent signiﬁcant level in all three countries. Kitamura / Research in International Business and Finance 23 (2009) 302–321 311 Fig. the vertical axis has the same scale.1. Since it is reasonable to assume that a country-speciﬁc productivity shock appears in its country-speciﬁc stock return. In the ﬁgures showing each country. current account. For ease of comparisons. and thereby on current account. the following interpretations mainly draw from those of Glick and Rogoff (1995). 1. row of Table 5 reports the root mean squared error (RMSE).K.

current account. models 3 and 5 accommodate the productivity shock and therefore perform well. The variance ratios of models 2 and 4 are greater than that of model 1 and relatively close to unity.312 Y. This implies that the effect of exchange rate is little signiﬁcant in the U. data.K.K. 1. for the U. Canada The SIC selects one lag for all the models in order to estimate the VAR system. Depending on the model. In other words. 2. while the VR of model 5 is closer to unity than that of model 3.K. one possible interpretation for this ﬁnding is that the country-speciﬁc productivity shock appears in its speciﬁc stock return in the U. Details of their performance can be found in Fig.K. In addition. 4. 2). Canada. The RMSE of model 4 is less than that of model 2. Models 2 and 3 consider the effect of exchange rate. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Fig. Models 2–4 are not rejected at the 5 percent signiﬁcant level. the above discussion leads us to conclude that model 5 shows the best performance for the U. current account. I examine the effect of exchange rate on the U.K. Finally. and the RMSE of model 5 is less than that of model 3.K. these variance . since it includes the country-speciﬁc stock return and ignores the exchange rate. the variance ratio of model 4 is closer to unity than that of model 2. and Rogoff (1995) show that a change in a country’s current account depends on its country-speciﬁc productivity shock but not on the global shock.. In contrast to the modeling of the U. while models 4 and 5 do not (Fig.2.2. since the latter affects all countries equally. In summary.

99b). In December of that year. import 98c. implying that the shock of U. 3.K. To measure the degree of openness. all the ICA models perform poorly in Japan. Japan. The sample mean of the U. share is approximately 66 percent. . This may be due to Canada’s extensive links with the U.6) and the Japan (30. the size of the matrix in Eq. ratios indicate that world stock return is a useful variable in the ICA model of Canada.9). Japan The SIC selects three lags for all the models in order to estimate the VAR system. Fig. GDP. 4. Kitamura / Research in International Business and Finance 23 (2009) 302–321 313 Fig. and this had 8 All 2006 yearly data are corrected from the IFS (export 90c.Y. 3 indicates a structural break around 1980. This may be due to the openness of the Canadian economy.S. In contrast to the results with the U. sums of export and import are divided by GDP.S.3 percent) was more open that that of the U. The variance ratio and the smallest RMSE of model 2 suggest the importance of exchange rate for the ICA model in Canada. Since shocks in the U. (60. The world real stock return is computed using time-varying weights for each country based on the proportion of total G7 GDP that corresponds to that country’s GDP. Therefore. economy appears in the world real stock return sufﬁciently.S.3. economy. and Canada.2. introducing world stock returns into the ICA model for Canada improves the model performance.S.K. (7) is 1 × 9.8 These statistics show that in 2006 the Canadian economy (70. also have a substantial effect on the Canadian economy and its permanent income. the “Foreign Exchange and Foreign Trade Control Law” in Japan was amended.

In other words. Nevertheless. The values of variance ratio and RMSE suggest better performance of models 4 and 5. Tables 6 and 7 and Fig. In the ﬁrst period. Moreover. where the variance corresponds to that of stock variables. I calculate the RMSE with the actual ca∗ and predicted t t ca∗ and the coefﬁcient of correlation between the random and stock variables. with the exception of its own autoregressive process and. and Canada and the data set from Q1 1981 to Q4 2007 for Japan. Thus. I use Japanese data from Q1 1981 through Q4 2007 and I take into account the 1980 amendment. This conﬂicts with the above hypothesis (˛1 = 0).s in Eq. Is a stock variable truly important for a current account? The empirical results show that the ICA model that includes a stock variable performs well. With this consideration in mind. Then I obtain the predicted ca∗ .. To obtain the RMSE and r v. The higher positive correlation between the random and stock variables means that the random variable captures more information on the ﬁrst moment of the stock variable. Before this amendment. (6) and (7) are estimated with no. This amendment allowed Japanese residents to freely transfer money into foreign countries. I run the following regression to test this hypothesis: RMSE = ˛0 + ˛1 r v. all ICA models are not rejected at the 5 percent signiﬁcance level. The second instance when the VAR parameter can be insigniﬁcant is when the stock variable has a non-linear effect on net output and the current account.s is the coefﬁcient of correlation between the random and stock variables and is a disturbance term. all ICA models generate more volatile current account series than what actually occurred. then we should observe a negative relationship between the RMSE and the coefﬁcient of correlation between the random and stock variables. This implies that the effect of exchange rates is little signiﬁcant in Japan. Like the U. I test this hypothesis formally as follows. where three and one lags are selected for each period.314 Y. Kitamura / Research in International Business and Finance 23 (2009) 302–321 profound effects on Japan’s current account. ca* . I generate the series of standard normal random variables. and so causes the model to perform worse during this time. the complete data sets are used. Finally. in terms of variance ratio and RMSE. (8). 4 report the results of each sample. a country-speciﬁc shock appears in its speciﬁc stock return. Using the full data set for the U. The results presented in Table 7 and Fig.3. respectively. I run the following regression for each modeling . and r* of the random variable. this variance ratio is better than that of model 1 (the world interest rate model). 4 are consistent with the 1980 amendment. With the exception of models 2 and 3 in Japan. which leads the model to predict more volatile series of the current account.K. there is no negative relationship between the RMSE and the coefﬁcient of correlation. the performance of model 5 is better than that of model 4. Japan. (4) is replaced with the random variable. (8) where r v. and the numbers in the second line are absolute t-statistics. (8). In the second period. and Q1 1981 to Q4 2007. For the other two countries.s + . Japanese residents were not allowed to smooth their consumption by borrowing or lending in international capital markets. but not its ﬁrst moment. One conservative interpretation of these results may be found in volatile stock variables: stock variables are more volatile than interest rates. I conclude that the movement of ﬁrst moment of the stock variable is important for the dynamics of current account. The stock variable rt in Eq. I split the Japanese sample into Q1 1960 to Q4 1980Q4. If the better performance (small RMSE) is due to the high-positive correlation between the random and stock variables. This is due to the fact that the ICA model assumes no obstructions to international transactions. which is inappropriate during the ﬁrst period. 4. the real stock market variable shows poor statistical signiﬁcance in the VAR results (Tables 3 and 6) for all countries. Eqs. is important for accurate modeling. all the estimated ˛1 s are negative and statistically signiﬁcant.K. in some cases. These sequences are t repeated 1000 times for each model (models 2–5). if only the volatility (second moment) of stock variable. First. Table 6 reports the VAR result. Table 8 reports the estimated parameters of Eq. model 5 performs best for Q1 1981 to Q4 2007 in Japan. Thus.

878 (0.000) 0.900 (0.002) 0.826) 0.819 (0.000) −0.410 ca∗ t −0.000) −0.023 (0.056) 0.000) 0.308 (0.791 (0.000) 0.094) 0.Table 6 VAR estimation for the subsample of Japan.104 (0.901) 0.104 (0.000) 0.761 0.926 75 3 0.157) 6.776) 0.026) −0.018 (0.594 Model 2 not −2.879 1.127) 0.049) 0.354) R2 NOB Lag (=i) max eig min eig 0.003) 0.000) 0.015 (0.645 (0.130 0.002) −0.292) 0.593 (0.014 (0.011 (0.922 75 3 0.911 (0.389 Sample period: 1981Q1–2007Q4 −0.153 (0.152 not−i (0.257) 0.311 (0.016 (0.042 (0.6E−05 (0.634 (0.822 (0.166 (0.200 Note: Please refer to the note in Table 3.489) 0.761 0.727) 0.523 (0.668 (0.340 (0.207 (0.002 (0.879 1.000) 0.009 (0.069) 3.721 (0.842) 0.080 (0.248 (0.842 rt∗ 1.069 (0.044 (0.278 Model 5 Y.827 (0.094) 0.000) 0.000) ∗ rt−i 0.886 (0.922) 1163.777 (0.362 Model 4 not −2.063 (0.001 (0.000) −0.178) 0.000) 0. 315 .200 −0.824 (0.094 (0.219 ca∗ t −0.828 (0.901 (0.001 (0.980 (0.002) −0.860 rt∗ 1.766 0.000) 0.460) 0.773 0.708) 0.589) 0.259) 0.348 0.194 106 1 0.826) 0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 not −2.7E−06 (0.002 (0.163) 0.480 −0.060) 0.851 rt∗ 55.923 75 3 0.900 (0.493) 0.228 106 1 0.097 ca∗ t 0.344 ca∗ t −0.972 0.000) 1.001 (0.212 (0.668 (0.001) ca∗ −0.875 (0.2E−05 (0.010) 0.069) 0.777) 0.080 (0.000) −0.183) 0.887 565.000) −0.930 75 3 0.871 (0.001 (0.030) R2 NOB Lag (=i) max eig min eig 0.371 (0.000) ca∗ 0.068 (0.800 (0.776) 0.083 (0.408 0.342) 0. Independent variable Model 1 not Sample period: 1960Q1–1980Q4 not−i −2.091) 2.100) 0.221 (0.166 (0.000) 1.116) ∗ rt−i 0.293) 0.001 (0.110 (0.919 75 3 0.000) 0.058 (0.000) 0.178 106 1 0.028 (0.972 0.211 (0.136 −0.209 105 1 0.293) 0.003) 0.215 (0.311 ca∗ t 0.903) 3.048) −0.009 (0.004) 0.000) 0.080) 0.538) 0.018 (0.120 (0.885 0.010 (0.215 (0.074 t−i (0.000) 0.130 0.178 106 1 0.693 (0.367) 386.879 1.002) 0.008 (0.046) 0.010 (0.069 (0.852 0.849 rt∗ 0.525 t−i (0.000) 0.000) −0.028) 0.889 (0.986) 0.962 (0.203 −0.110 (0.247) 0.879) 0.878 rt∗ 1.083 (0.000) 0.010) 0.075 (0.052) −6.973 0.777) 0.361 0.199 Model 3 not −2.975 0.811 (0.002 (0.247) 0.703) 0.001 (0.011) 0.091) 2.970 0.094) 0.028 (0.004 (0.

243 [0.246 [0.010] 0.367 0.000] Model 2 0.010] 0.619 6074.510 [0.2E−06 [0.5E−04 [0.4E−05 [0.007] Model 2 0.105] 1.009] 0.511 8682.402] 0.719 [0.011] −0.397 3.653 [0. .727 [0.563 0.744 Note: Please refer to the note in Table 5.991 8010.462 2.084 [0.146 [0.248 [0.180 [0.000] 0.013 [0.722] 4.725] 0.008 [0.010] 0.496 [0.337] 0.147] −3.000] Model 3 0.014] 0.985 [0.008] 0.000 81.024 [0.120] 0.721] 4.668 not−2 ca∗ t−2 ∗ rt−2 0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Sample period 1960Q1–1980Q4 Model 1 not ca∗ t rt∗ not−1 ca∗ t−1 ∗ rt−1 Sample period 1981Q1–2007Q4 Model 3 0.063 [0.007] 0.0001 13.0311 0.246 [0.661 [0.1E−06 [0.455 2.419] −0.008] −0.652 1.0001 1.742 [0.541 [0.944 [0.010] 0.0332 1.165] −0.363 1.009] −0.107] 1.001 [0.494 [0.013] 0.326] −1.100] 0.176] −6.002 [0.025 [0.000] 0.010] 0.140 [0.106] 0.611 Model 5 0.709 [0.011] −0.949 0.142] 0.0001 1.009] 0.970 1.483 0.841 VR Wald salt p-value RMSE (×1000) 0.200] 0.932 9429.447 [0.000] Model 4 0.195] −0.008 3.830 Model 1 0.009] 0.000 81.008] −0.008] 0.732 [0.176 [0.0281 14.991 [0.191 [0.266] 0.729 [0.567 0.008] 0.885 Model 4 0.179 [0.460 1.193 0.307 [0.492 [0.910 0.008] 0.541 0.611 3.105] 1.678] 3.009] Model 5 0.144] −0.149] −0.963 0.014 [0.3E−06 [0.234] −0.114 [0.500 [0.000 80.001 [0.2830 13.006] 0.735] 7.398 [0.0250 14.316 Table 7 Estimation results of the ICA model for the subsample of Japan.0001 13.4E−05 [0.194] 0.003 [0.8E−05 [0.258 [0.674 5640.633 0.012] 0.0001 1.400 3.819 0.244 [0.013] 0.345] −0. Y.012] 0.000 80.188 [0.467 [0.268 [0.461 0.856 0.568 [0.138 [0.163] 0.000 80.489 [0.000] 0.488 [0.012 [0.189 [0.496 0.

The subsample of Japan.Y. 4. . Kitamura / Research in International Business and Finance 23 (2009) 302–321 317 Fig.

“NOB” is the number of observations.415 0.045 1000 Model 5 0.013 6.009 52.043 8.019 50.007 58.052 1000 Model 4 0.K.680 −0.012 54.499 0.002 7.073 1000 Note: The ordinary least square (OLS) estimator is reported.041 8.433 −0.027 1000 Model 4 0.010 55.242 −0.009 5.231 0.608 0.190 0.289 0.019 53.013 4.615 0. .003 99.012 1000 Japan Model 2 0.555 0.921 0.020 1000 Model 5 0.079 1000 Model 4 0.066 1000 Canada Model 2 0.163 −0.011 52.074 1000 Model 3 0. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Table 8 Estimation results of Eq.680 −0.905 −0. The U.010 3.044 9.479 0.002 8.830 0.435 0. (8).019 52.007 56.741 −0.003 103.039 7.009 5.055 1000 Model 5 0.019 52.859 0. The number in the second line is an absolute t-statistic.368 0.006 −0.016 8.274 −0.289 −0.066 1000 Model 3 0. Model 2 ˛0 ˛1 R2 NOB 0.026 1000 Model 3 0.318 Y.

008 (0. of the stock variable: not = Â11 ca∗ t = Â21 ∗ ∗ not−1 + Â12 ca∗ + Â13 rt−1 + DumÂ14 rt−1 + Á1.492) 1.054 (0.5E−05 (0.025 (0.011 (0.024) 0.487) 0.001 (0.295) 0.895 (0.087) 0.902 (0.472) 7.064 (0. (9) and (10) (for models 2–5).900 (0.094) 0.009 (0.465) −0.029 (0.298) 0.477) 0.033 (0.017 (0. its value is zero.007 (0.312 (0.278) 0.188 (0.374) −0.032) 0.005 (0.6E−05 (0.000) 0. “NOB” is the number of observations.119 185 R2 NOB (Part B) Canada not−1 ca∗ t−1 ∗ rt−1 ∗ Dum × rt−1 −0.105) 0.K.918 (0.083 (0.192 (0.038 (0.111) 0.123 185 ca∗ t −0.034) 0.078 (0.033) −0.001 (0.098) 0.003 (0.008 (0.450) −0.192 (0.8E−05 (0.005 (0.357) −0.000) −0.041) 0.465) 0.039 105 0. These ﬁndings may suggest that the stock variable has a non-linear effect on net output and on the current account.123 185 ca∗ t −0.084 (0.000) 0.000) 0.100 185 −0. t−1 (9) (10) not−1 + Â22 ca∗ t−1 ∗ + Â23 rt−1 ∗ + DumÂ24 rt−1 + Á2.1E−05 (0.313 (0.Y.022) −0.136) 0.085 (0.253 (0.048 105 0.033) −1.3E−04 (0.352) 0.000) 0.001 (0.795 185 −0.296) 0.242) 0.378) 0.024) 0.127) 0.024 (0.025 (0. .889 (0.016 (0.019 (0.044) 0.049) 0.072 (0. where Á is a disturbance term.303) 0.071 (0.039 106 0.865 106 −0.007 (0.058 106 0. Table 9 reports the estimated parameters for each modeling of the stock variable (models 2–5).070 (0.406) 0.029 (0.007) 0.399) 0.407) 0.795 185 −0. all other change in the stock variable (Â 13 and Â 23 ) are statistically signiﬁcant in the ca* equation of models 2 and 3.009 (0.102) 0.308) 0.046) −0.824 185 not −0. The number in parenthesis is a p-value for t-statistic. The number in parenthesis is a p-value for t-statistics.822 185 −0.003 (0.000) −0.4E−05 (0.101 (0.056) 0.070) −0.108 185 −0.000) −0.t . Independent variable Model 2 not (Part A) The U.920 (0. In that country.316) 0. although this is not the case in Japan.825 185 Model 5 not −0.016 (0.266 (0.027) −0.001 (0.130) 0.225 (0.413) 0.122) 0.924 (0.003 (0.892 (0.015 (0.344) 0.858 106 −0.014 (0. and Canada.857 105 R2 NOB Note: The table reports the OLS estimator of Eqs.092) 0.322 (0. otherwise.000) −0.005 (0.003 (0.121) 0.013 (0. (9) and (10).6E−06 (0.393) −1.119) 0.013 (0.016 (0.077 (0.082) −0.194) 0.792 185 −0.271) 0.061) 0.059) 0.060) 0.002 (0.927 (0.925 (0.000) −0.195) 0.000) 2.795 185 R2 NOB (Part C) Japan not−1 ca∗ t−1 ∗ rt−1 ∗ Dum × rt−1 −0.003 (0. I obtain signiﬁcant parameters (at the 5 or 10 percent level) for both large changes (Â 14 and Â 24 ) and all other change (Â 13 and Â 23 ) in the stock variable.124 185 −0. This assumes that the large movement in the stock variable does affect a current account differently from its all other change. not−1 ca∗ t−1 ∗ rt−1 ∗ Dum × rt−1 319 Model 3 ca∗ t −0.363) −1.165) −0.017 (0. “Dum” is a dummy variable that takes a value of one when the stock ∗ variable rt−1 is greater than two standard error bands.000) −0.216) 0.0E−05 (0.001 (0.000) 0.019 (0.015 (0.487) 0.328 (0.002 (0.000) 0.218 (0.864 105 −0.000) −0.K.002 (0.000) −0.886 (0.316) 0.9E−05 (0.057 (0.000) −0.014 (0.034) −0.000) 2. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Table 9 Estimation results of Eqs.351) 0.436) 0.054) 0.055) 0.001) −0.004 (0.271) 0.058) −0.372) 0.019 (0.225) 3.028 (0. In some cases for the U.896 (0.116 185 ca∗ t −0.037) 0.004 (0.192 (0.039) −1.019 (0.003 (0.001) −0.008 (0.t .822 185 Model 4 not −0.000) −0.034 (0.091 185 −0.

agents save a part of it and a country runs a current account surplus. Carnegie-Rochester Conf.D. S.M. M. J. Polit..R. J. The role of stock markets in current account dynamics: a time series approach. G. Hall. Publ. Conclusion This study empirically examines the explanatory power of the stock return in the intertemporal approach to a current account (ICA). 971–987. Princeton University Press. This study leaves unresolved the question of why the stock variable shows weak explanatory power in the VAR system. 11. J. 1062–1088. 105.M. Sheffrin. 86 (6). 1995. 159–192. 5. In: Grossman. A. 3 (1). Econ.. Obstfeld. the results of Tables 8 and 9 suggest that models that take into consideration the stock variable perform well not because of particularities for speciﬁc countries. 3.. R. 414–430. (Eds. N. Rogoff. 2003a. 1994. Kitamura / Research in International Business and Finance 23 (2009) 302–321 Another instance when the VAR parameter can be insigniﬁcant is that a stock adjustment has different effects on the current account from each other. References Apergis.M. 2003b.. Money Finan. 2006.. In addition. Ghosh. Ser. 1995.R. 110. exchange rates and present value models of the current account. S. B. . depending on whether a stock price adjustment reﬂects a change in permanent income or not. If this scenario is valid. Mercereau. Lett. even when a change in stock price affects current income but not permanent income. The empirical result of this paper shows that the ICA model performs well for all of the sample countries once the stock variable is taken into consideration. G.. 1976. Monetary Econ. 35. K.. Global versus country-speciﬁc productivity shocks and the current account. One possible interpretation for this ﬁnding is that an agent optimally smoothes consumption based on stock market information. J. Cointegration and tests of present value models. Time Series Analysis. Glick. Princeton.E. the stock market model can capture the consumption behavior of an agent and the dynamics of the current account. J. according to the permanent model of consumption. In summary. R. Acknowledgement I would like to thank an anonymous referee for constructive comments and invaluable suggestions that have substantially improved the paper. According to the permanent income model of consumption. Polit.320 Y. Stochastic implication of the life cycle-permanent income hypothesis: theory and evidence. 2000. 1992. the adjustment causes a current account deﬁcit if permanent income rises more than current income. Top. Econ. Campbell. The intertemporal approach to the current account.B. Miller. 21. Consumption asymmetry and the stock market: empirical evidence. In other words.. Int. 93. Money Finan. 1995. 95 (5)..Y. Econ. but because the stock variable explains movement in the current account. 385– 412. Rogoff... K.. ˙¸ Iscan. J. 337– 342. Econ. Testing a present-value model of the current account: evidence from United States and Canadian time series. R.. 1987. all errors are my own. Policy 1. Bergin. Present value tests of the current account with durables consumption. J. this income change may cause movement of the current account as a result of agents’ actions to smooth consumption. When a rise in stock price increases only current income. Amsterdam. Hamilton. Otto. 19–46. Macroecon. 1978..). Naturally.. North Holland. when a positive stock adjustment is related to a change in permanent income. The Role of Stock Markets in Current Account Dynamics: Evidence from the United States.J. This should be investigated further in future studies. 535–558. I should decompose a stock variable into permanent and transitory components. R... Rogoff. since stock return is an informative variable for permanent income. Handbook of International Economics. J. 2002. vol. Econometric policy evaluation: a critique. International capital mobility amongst the major industrialized countries: too little or too much? Econ.. Lucas Jr. Interest rates. 107–128. IMF Working Papers 03/108. J.. Int. Shiller. Mercereau. K.E. T.. Future research should therefore examine several different effects of the stock variable on current accounts. P. B.

M. Activity 2. Stock ownership patterns. W. stock market ﬂuctuations.M. Kitamura / Research in International Business and Finance 23 (2009) 302–321 321 Poterba. 295–372.. and consumption. A. Sachs. Money Finan. Int. Quart. 597–624. 1982. C. Boston. J. 105. Brookings Pap. 220–233.. Woo. Sargent. 1990. The Great Crash and the onset of the Great Depression..A. Econ.Y.J. Samwick. Sheffrin..T.. J. Testing an optimizing model of the current account via the consumption function. Econ. J. Scand. 147–159. J.. 1995. S. T. 84. J. 9. .. Econ. 1990. Romer. 1987. Academic Press. Macroeconomic Theory. The current account in the macroeconomic adjustment process.

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