The literature in international economics and finance can be split along several paradigms:
small open economy (partial equilibrium) vs. general equilibrium; pure exchange vs. production
economies; single- vs. multiple-good models; complete vs. incomplete markets. It
is impossible to summarize the research that has been done in all these areas.1
In this survey
we concentrate on a framework that has become the core of international macro-finance:
general equilibrium asset-pricing models with multiple goods. The richness of this framework
comes at a cost: most of the macro-finance models are quite complex. This literature can
be split into several parts based on their approaches. The first approach relies on traditional
approximation methods. Ghironi, Lee, and Rebucci (2006) and Kollmann (2006) compute
portfolios and changes in net foreign assets using standard first-order approximations around
a deterministic steady state. The second approach makes use of higher-order approximations
to analyze countries’ portfolios and the evolution of external accounts. These methodologies
grew out of Samuelson (1970) and Judd and Guu (2001) and were developed by Engel and
Matsumoto (2006), Evans and Hnatkovska (2007), Devereux and Sutherland (2010a), and
Tille and van Wincoop (2010). A disadvantage shared by these two approaches is that to
this day little is known about the behavior of these economies away from the deterministic
steady state, where the underlying volatilities are not small.2