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Understanding International Portfolio Diversification and Turnover Rates

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  • Amir Amadi
  • Paul Bergin

Abstract

This paper argues that fixed trading costs in international asset markets help explain equity home bias. This contrasts with explanations prevalent in international macroeconomics, which tend to be based on trading frictions instead in international goods markets, such as nontraded goods or transportation costs. While the stylized fact of high trading turnover in foreign holdings has been interpreted as evidence against international asset trading costs, we show that this argument only applies to costs that are proportional to trade, and not to fixed costs of entering the foreign market. After documenting that the home bias and turnover stylized facts remain valid in recent data, the paper constructs a very simple portfolio allocation model with various configurations of trading costs and with heterogeneous types of traders. A configuration with per unit costs heterogeneous among agents and a homogeneous fixed cost is found to replicate the pair of stylized facts. Intuitively, the lower trading costs that characterize larger and more efficient traders have two implications: firstly, these traders find it more profitable to enter foreign markets; secondly, their lower trading costs encourage a higher rate of trading turnover. Since holdings of international equities are disproportionately dominated by this class of larger and more efficient traders, average trading turnover is higher among international holdings.

Suggested Citation

  • Amir Amadi & Paul Bergin, 2006. "Understanding International Portfolio Diversification and Turnover Rates," NBER Working Papers 12473, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12473
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    References listed on IDEAS

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    3. Giofré, Maela, 2017. "Financial education, investor protection and international portfolio diversification," Journal of International Money and Finance, Elsevier, vol. 71(C), pages 111-139.
    4. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," Journal of Economic Literature, American Economic Association, vol. 51(1), pages 63-115, March.
    5. Swarn Chatterjee, 2009. "Immigrants Have Lower Participation Rates In U.S. Financial Markets?," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 3(2), pages 1-13.
    6. Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108-1159.
    7. Kapteyn, Arie & Teppa, Federica, 2011. "Subjective measures of risk aversion, fixed costs, and portfolio choice," Journal of Economic Psychology, Elsevier, vol. 32(4), pages 564-580, August.
    8. Ni, Jinlan, 2009. "The effects of portfolio size on international equity home bias puzzle," International Review of Economics & Finance, Elsevier, vol. 18(3), pages 469-478, June.
    9. Christelis, Dimitris & Georgarakos, Dimitris, 2013. "Investing at home and abroad: Different costs, different people?," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 2069-2086.
    10. Geromichalos, Athanasios & Simonovska, Ina, 2014. "Asset liquidity and international portfolio choice," Journal of Economic Theory, Elsevier, vol. 151(C), pages 342-380.
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    12. Hnatkovska, Viktoria, 2010. "Home bias and high turnover: Dynamic portfolio choice with incomplete markets," Journal of International Economics, Elsevier, vol. 80(1), pages 113-128, January.
    13. repec:hal:spmain:info:hdl:2441/1shj1p7td8e0r5c9fcsnk8a91 is not listed on IDEAS
    14. Nicolas Coeurdacier & Hélène Rey, 2010. "Home bias in open economy financial macroeconomics," SciencePo Working papers Main hal-01069440, HAL.
    15. Roland Straub & Luca Dedola & Giovanni Lombardo, 2011. "Home bias and portfolio dynamics in a multi-country model," 2011 Meeting Papers 1037, Society for Economic Dynamics.
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    17. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," SciencePo Working papers hal-03473901, HAL.

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    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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