Is the valuation effect always beneficial for adjusting external imbalances?

This paper investigates implications of the valuation effect on a number of international macroeconomic issues. Emphasizing that the valuation effect is a wealth transfer among countries through capital gains or losses, it mainly concentrates on studying implications of the valuation effect on international risk sharings and external imbalances. For these purposes, a standard two-country monetary macroeconomic model is considered and the financial integration is embedded through cross-border asset holdings. Main findings of this paper can be summarized as follows: First, the valuation effect works mainly as an impact effect and it depends crucially on initial movements of nominal exchange rates and asset prices. Second, the valuation effect can matter quantitatively depending on the composition of external asset position and types of shocks. Especially, when bonds are main components in external asset position and a monetary shock hits the economy, the valuation effect is conspicuous. Finally, the valuation effect can exert considerable influences on the economy. Specifically, under certain circumstances, it can work against international risk sharings and magnify external imbalances by amplifying the effects of a shock.