Consumption hedging and home-country bias in a model of international capital market equilibrium
AbstractPurpose – The purpose of this paper is to develop a model of international capital market equilibrium where investors exhibit home-country bias due to their desire to hedge real consumption. Design/methodology/approach – This paper posits a two-stage process of portfolio choice for the representative investor of a country. In the first step, the investor's benchmark portfolio is determined, whereas in the second step, his optimal portfolio is chosen. The latter portfolio maximizes the expected portfolio rate of return minus the risk tolerance weighted variance of tracking error. The market equilibrium implications of the portfolio optimality conditions are determine via aggregation across all investors and countries. Findings – A revised security market line is derived that differs from the traditional security market line in terms of vertical intercept, slope, and beta coefficient. It is demonstrated that the derived model may be interpreted as a multi-country generalization of the Chen-Boness extension of the capital asset pricing model under uncertain inflation. Originality/value – This paper presents an innovative application of Roll's tracking portfolio paradigm. Another novel feature is the derivation of the international capital market equilibrium implications of such portfolio choice behaviour.
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Bibliographic InfoArticle provided by Emerald Group Publishing in its journal Studies in Economics and Finance.
Volume (Year): 29 (2012)
Issue (Month): 1 (March)
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
- Alan G. Ahearne & William L. Griever & Francis E. Warnock, 2000.
"Information costs and home bias: an analysis of U.S. holdings of foreign equities,"
International Finance Discussion Papers
691, Board of Governors of the Federal Reserve System (U.S.).
- Ahearne, Alan G. & Griever, William L. & Warnock, Francis E., 2004. "Information costs and home bias: an analysis of US holdings of foreign equities," Journal of International Economics, Elsevier, vol. 62(2), pages 313-336, March.
- Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
- Grauer, Frederick L. A. & Litzenberger, Robert H. & Stehle, Richard E., 1976. "Sharing rules and equilibrium in an international capital market under uncertainty," Journal of Financial Economics, Elsevier, vol. 3(3), pages 233-256, June.
- Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-34, September.
- Margarida Abreu & Victor Mendes & João A. Santos, 2010.
"Home Country Bias: Does Domestic Experience Help Investors Enter Foreign Markets?,"
2010/02, Department of Economics at the School of Economics and Management (ISEG), Technical University of Lisbon..
- Abreu, Margarida & Mendes, Victor & Santos, João A.C., 2011. "Home country bias: Does domestic experience help investors enter foreign markets?," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2330-2340, September.
- Black, Fischer, 1974. "International capital market equilibrium with investment barriers," Journal of Financial Economics, Elsevier, vol. 1(4), pages 337-352, December.
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