Revisiting the role of excess returns and the discount factor in the US international debt dynamics.

What is it about?

I provide a new decomposition of the external constraint of a country in which, in addition to trade and valuation channel, adjustments in the stochastic discount factor and the spread between average international returns and risk-free rate can offset a current debt position. The importance of these channels is empirically assessed using US data. A primary contribution of the discount factor and secondary effects of excess and average returns are found in the non-detrended analysis, confirming the theoretical characterization of the valuation effects in previous literature. By using detrended data instead, the role of excess returns would be spuriously overestimated.

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Why is it important?

The paper shows that excess returns are not so important in explaining the dynamics of the international position of countries, neither theoretically nor empirically for the US. This is an important change in view about the possible contribution of excess returns in the sustainability of the external debt, which should not be considered a valid alternative to the traditional trade channel.