Comments on Forbes, Fratzscher, Kostka and Straub “Bubble Thy Neighbor: Portfolio Effects …” Andrew K. Rose Berkeley-Haas, CEPR and NBER 1

Key Message Brazil’s bond taxes lower: 1.Brazilian bond holding 2.Equity holdings in “control risk” countries (Colombia, Indonesia, Peru, Thailand ….) Focus in this paper: cross-country Also interesting: cross-asset – Brazilian bond taxes lowers Brazilian equity holdings more than Brazilian bonds! (Table 6) 2

The Good 1.Good Question – Interesting, original, topical, important 2.New Data Set 3.Choice of Brazil – Good tax variation – Important country, possibility of spillovers 4.Very Careful, Thorough Work – Frustratingly so (for discussant) – Nice Quantitative Summary of Effects – Most Caveats included 3

Not as Good How scalable is the finding? Interview evidence from equity investors makes it look like taxes should be irrelevant (makes one suspicious of a fishing expedition) – Ex: is three months optimal? – Ex: why use change in IOF for just bonds? Little motivation for externalities from interviews Is stronger coverage of equity (4x bonds) the reason for findings? – Data coverage, not true effect? Some (mild) over-statement – But most results shown, warts and all; authors very aware of sensitivities 4

Nit-Picking? If Brazil weight falls, then something else must rise (possibly cash) Odd that effects of IOF are: – 16.6%-19.7% for global equity funds – Only 3.1%-4.8% for global emerging market equity – Only % for Latin American regional equity – Only 5-5.1% for Global emerging market bonds Would have expected opposite! 5

Most Externality Estimates Small Ex: discussion (p19) of Table 4 (key!) “This indicates that there are no significant externalities from changes in the IOF on average portfolio allocations to all other countries in the sample.” 6

Bubble thy Neighbor? Where’s the evidence of bubbles? If pecuniary externality with complete markets, effects offset each other; Pareto efficiency – Reasonable in financial markets? “Bubble” a loaded word 7

A Worry: Low Effect of Benchmark Looks like 1:1 effect in Figure 1 Very far from 1 in empirics (β≈.7) – Why so low? Measurement Error? Something that requires IV? – First “Iron Law” of Econometrics: coefficients biased down Why not impose coefficient of 1 on benchmark? 8

Referee Questions/Points Why start in 2006, not earlier? Trade Diversion analogy a red herring – Trade diversion with discriminatory taxes, differential prices (RTAs are not multilateral) – Irrelevant here! Box-Cox test for levels vs. logs If errors iid in (1), should be MA(1) in (2) – More generally: test for dynamics? – Especially with transitory taxes? Is (3) necessary? – Usually don’t care about covariances between regressors Descriptive statistics in Table 3 would help 9

My Take: Believable … on Brazil Evidence of Externalities Weak – Most direct evidence is negative: why so little effect on bonds? – Little in Tables 4-6 – Relatively little evidence on equities too Appeal to Signaling Story (Bartolini-Drazen) – But no direct evidence of signaling – Just a consistent interpretation 10