Excess Returns, Average Returns and the Adjustment Mechanism of the External Position of a Country

I provide a new decomposition of the external constraint of a country in which, in addition to the 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.