INCREASING RETURNS AND CYCLICAL INTERNATIONAL CAPITAL MOVEMENTS

This paper introduces increasing returns to domestic capital into a st andard optimizing model of international portfolio selection. The resu lting system displays surprising dynamic behavior. Endogenous cycles o f any length may occur around the steady-state equilibrium, with both capital flows and asset prices displaying regular fluctuations. Initia l conditions and expectations both matter in selecting the cycle on wh ich the economy converges. Hence, 'animal spirits' may determine the c ourse of asset prices and capital flows.