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Hedging against the government: a solution to the home asset bias puzzle

Author

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  • Tiago C. Berriel
  • Saroj Bhattarai

Abstract

This paper explains two puzzling facts: international nominal bonds and equity portfolios are biased domestically. In our two-country model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: some nominal risk and taxes falling only on domestic agents. A third feature explains why agents choose to hold primarily domestic equity: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. These conclusions are robust to a wide range of preference parameter values and the incompleteness of financial markets. A calibrated version of the model predicts asset holdings that quantitatively match the data.

Suggested Citation

  • Tiago C. Berriel & Saroj Bhattarai, 2012. "Hedging against the government: a solution to the home asset bias puzzle," Globalization Institute Working Papers 113, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddgw:113
    Note: Published as: Berriel, Tiago C. and Saroj Bhattarai (2013), "Hedging Against the Government: A Solution to the Home Asset Bias Puzzle," American Economic Journal: Macroeconomics 5 (1): 102-134.
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    References listed on IDEAS

    as
    1. Backus, David K & Kehoe, Patrick J, 1992. "International Evidence of the Historical Properties of Business Cycles," American Economic Review, American Economic Association, vol. 82(4), pages 864-888, September.
    2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(2), pages 443-473.
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    More about this item

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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