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Multilateral Resistance to International Portfolio Diversification

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  • Paul R. Bergin
  • Ju Hyun Pyun

Abstract

Not only are investors biased toward home assets, but when they do invest abroad, they appear to favor countries with returns more correlated with home assets, reducing diversification yet further. This paper argues that understanding this correlation puzzle requires a multi-county theoretical perspective, and we construct an N-country DSGE model that allows for heterogeneous stock return correlations. It shows that bilateral asset holdings depend not only upon the stock return correlation with the destination country, but also on the correlation with all other countries. This effect is analogous to ‘multilateral resistance’ in the trade literature. An empirical study controlling for this multilateral resistance in correlations overturns the result of preceding literature, finding that higher stock return correlation lowers bilateral equity asset holdings as theory predicts, reducing the losses of home bias.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17907.

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Date of creation: Mar 2012
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Handle: RePEc:nbr:nberwo:17907

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Cited by:
  1. Buch, Claudia M. & Neugebauer, Katja & Schröder, Christoph, 2013. "Changing forces of gravity: How the crisis affected international banking," Discussion Papers 48/2013, Deutsche Bundesbank, Research Centre.

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