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International portfolios, capital accumulation and foreign assets dynamics

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  • Coeurdacier, Nicolas
  • Kollmann, Robert
  • Martin, Philippe

Abstract

Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation and international trade in stocks and bonds. In our model, domestic stocks are used to hedge fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversification does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital flows.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 80 (2010)
Issue (Month): 1 (January)
Pages: 100-112

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Handle: RePEc:eee:inecon:v:80:y:2010:i:1:p:100-112

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: Capital accumulation International equity and bond portfolios Capital flows Current account Valuation effects Terms of trade;

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