Can a standard open economy macro model generate realistic international diversification in debt AND equity? We address this question by solving for steady-state portfolios in a two-country, two-good DSGE endowment model with consumption home bias. We compare two different asset trading regimes. In the first, households in each country trade equity claims on their underlying stochastic endowments; in the second, households trade locally-denominated bonds. We derive locally accurate closed-form solutions for steady-state portfolios under each regime. The model can predict realistic home equity bias and bond diversification if the intratemporal elasticity of substitution between home and foreign goods is sufficiently low. However, for commonly used parameter values, the standard two-good model understates bond diversification and overstates equity diversification. Classification-JEL Codes: F36, F41, G11
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Paper provided by Georgetown University, Department of Economics in its series Working Papers with number
gueconwpa~09-09-01.
Length: Date of creation: Date of revision: Handle: RePEc:geo:guwopa:gueconwpa~09-09-01
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References listed on IDEAS 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.:
Pavlova, Anna & Rigobon, Roberto, 2003.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]
Pavlova, Anna & Rigobon, Roberto, 2004.
"Asset Prices and Exchange Rates,"
Working papers
4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
[Downloadable!]