Portfolio Choice in a Monetary Open-Economy DSGE Model

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Portfolio Choice in a Monetary Open-Economy DSGE Model

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Charles Engel
Akito Matsumoto

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Abstract

This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some goods prices are set without full information of the state. We show that temporarily sticky nominal goods prices can have large effects on equity portfolios. Home and foreign portfolios are not identical in equilibrium. In response to technology shocks, sticky prices generate a negative correlation between labor income and the profits of domestic firms, biasing portfolios in favor of home equities. In contrast, under flexible prices, labor income and the profits of the domestic firms are positively correlated. Even a small amount of nominal price stickiness can generate these portfolio differences, depending on the diversification role played by the terms of trade. Returns on human capital and equities may be positively correlated under sticky prices when the source of shocks is monetary, but this risk is hedged through nominal assets rather than through equities.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12214.

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Date of creation: May 2006
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Handle: RePEc:nbr:nberwo:12214

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Paper
- Charles Engel & Akito Matsumoto, 2005. "Portfolio Choice in a Monetary Open-Economy DSGE Model," IMF Working Papers 05/165, International Monetary Fund. [Downloadable!]

Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-05-20 (All new papers)
NEP-CBA-2006-05-20 (Central Banking)
NEP-DGE-2006-05-20 (Dynamic General Equilibrium)
NEP-FIN-2006-05-20 (Finance)
NEP-FMK-2006-05-20 (Financial Markets)
NEP-IFN-2006-05-20 (International Finance)
NEP-MAC-2006-05-20 (Macroeconomics)

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