This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

The international diversification puzzle is not as bad as you think

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Jonathan Heathcote
Fabrizio Perri

Additional information is available for the following registered author(s):

Abstract

In the data country portfolios are heavily biased toward domestic assets. Standard one-good international macro models predict that, due to the presence of non-diversifiable labor income risk, country portfolios should be heavily biased toward foreign assets; this discrepancy constitute the international diversification puzzle. (Baxter and Jermann, 1997). We show that a simple extension of one-good models help reconcile theory and data. In particular we analytically solve for the equilibrium country portfolios in a two-country, two-goods model with non-diversifiable labor income and investment. In this set-up, consistently with the data, country portfolios contain a relatively small, but positive, share of foreign assets. The reason why international diversification is low is that terms of trade movements provide considerable insurance against country specific shocks and labor income risk (Cole and Obstfeld 1991, Acemoglu and Ventura, 2001). The reason why international diversification is positive is that foreign assets are crucial to share the financing of investment across countries. Finally in the model a country’s share of foreign assets should depend on its import share and on its capital share. We show how this relation is qualitatively and quantitatively consistent with country portfolios in the cross section of OECD countries in the 1990s.

Download Info
To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Publisher Info
Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 152.

Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote), ReDIF
Length:
Date of creation: 2004
Date of revision:
Handle: RePEc:red:sed004:152

Contact details of provider:
Postal: Society for Economic Dynamics Anne Stubing CV Starr Center for Applied Economics 269 Mercer Street, Room 303 New York University New York, NY 10003
Fax: 1-860-486-4463
Email:
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC

For technical questions regarding this item, or to correct its listing, contact: (Christian Zimmermann).

Related research
Keywords: home bias; international risk sharing;

Other versions of this item:

Find related papers by JEL classification:
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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.:

  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
    Other versions:
  2. Cantor, Richard & Mark, Nelson C, 1988. "The International Transmission of Real Business Cycles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 493-507, August. [Downloadable!] (restricted)
  3. Tesar, Linda L., 1993. "International risk-sharing and non-traded goods," Journal of International Economics, Elsevier, vol. 35(1-2), pages 69-89, August. [Downloadable!] (restricted)
  4. Susanto Basu & John G. Fernald & Miles S. Kimball, 2006. "Are Technology Improvements Contractionary?," American Economic Review, American Economic Association, vol. 96(5), pages 1418-1448, December. [Downloadable!]
    Other versions:
  5. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359. [Downloadable!] (restricted)
  6. Martin D. D. Evans (Georgetown University) and Viktoria Hnatkovska (Georgetown University), . "Solving General Equilibrium Models with Incomplete Markets and Many Assets," Working Papers gueconwpa~05-05-18, Georgetown University, Department of Economics. [Downloadable!]
    Other versions:
  7. Nicolas Coeurdacier, 2006. "Do trade costs in goods market lead to home bias in equities?," 2006 Meeting Papers 111, Society for Economic Dynamics. [Downloadable!]
  8. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, vol. 87(1), pages 170-80, March. [Downloadable!] (restricted)
    Other versions:
  9. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-85, March. [Downloadable!] (restricted)
    Other versions:
  10. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2006. "Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism Among G7 Countries," NBER Working Papers 12483, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  11. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June. [Downloadable!] (restricted)
  12. Portes, Richard & Rey, Helene, 2005. "The determinants of cross-border equity flows," Journal of International Economics, Elsevier, vol. 65(2), pages 269-296, March. [Downloadable!] (restricted)
    Other versions:
  13. David K. Backus & Gregor W. Smith, 1992. "Consumption and Real Exchange Rates in Dynamic Exchange Economies with Nontraded Goods," Working Papers 92-7, New York University, Leonard N. Stern School of Business, Department of Economics.
  14. Uppal, Raman, 1993. " A General Equilibrium Model of International Portfolio Choice," Journal of Finance, American Finance Association, vol. 48(2), pages 529-53, June. [Downloadable!] (restricted)
  15. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  16. Daron Acemoglu & Jaume Ventura, 2002. "The World Income Distribution," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 659-694, May. [Downloadable!] (restricted)
    Other versions:
  17. Karsten Jeske, 2001. "Equity home bias: Can information cost explain the puzzle?," Economic Review, Federal Reserve Bank of Atlanta, issue Q3, pages 31-42. [Downloadable!]
  18. Charles Engel & Akito Matsumoto, 2006. "Portfolio Choice in a Monetary Open-Economy DSGE Model," NBER Working Papers 12214, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  19. Eric van Wincoop & Francis E. Warnock, 2006. "Is Home Bias in Assets Related to Home Bias in Goods?," NBER Working Papers 12728, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  20. Cole, Harold, 1988. "Financial Structure and International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(2), pages 237-59, May. [Downloadable!] (restricted)
  21. Amir Amadi & Paul Bergin, 2006. "Understanding International Portfolio Diversification and Turnover Rates," NBER Working Papers 12473, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  22. Ignacio Palacios-Huerta, 2001. "The Human Capital of Stockholders and the International Diversification Puzzle," Working Papers 2001-12, Brown University, Department of Economics.
    Other versions:
  23. Brainard, William C & Tobin, James, 1992. "On the Internationalization of Portfolios," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 533-65, October. [Downloadable!] (restricted)
    Other versions:
  24. Aart Kraay & Norman Loayza & Luis Servén & Jaume Ventura, 2005. "Country Portfolios," Journal of the European Economic Association, MIT Press, vol. 3(4), pages 914-945, 06. [Downloadable!] (restricted)
    Other versions:
  25. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April. [Downloadable!] (restricted)
    Other versions:
  26. Lewis, Karen K, 1996. "What Can Explain the Apparent Lack of International Consumption Risk Sharing?," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 267-97, April. [Downloadable!] (restricted)
  27. Douglas Gollin, 2002. "Getting Income Shares Right," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 458-474, April. [Downloadable!] (restricted)
    Other versions:
  28. Anna Pavlova & Roberto Rigobon, 2007. "Asset Prices and Exchange Rates," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 20(4), pages 1139-1180. [Downloadable!] (restricted)
    Other versions:
  29. Juan Carlos Hatchondo, 2005. "Asymmetric information and the lack of international portfolio diversification," Working Paper 05-07, Federal Reserve Bank of Richmond. [Downloadable!]
  30. Gehrig, Thomas, 1993. " An Information Based Explanation of the Domestic Bias in International Equity Investment," Scandinavian Journal of Economics, Blackwell Publishing, vol. 95(1), pages 97-109.
  31. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January. [Downloadable!] (restricted)
    Other versions:
  32. Peter M. Demarzo & Ron Kaniel & Ilan Kremer, 2004. "Diversification as a Public Good: Community Effects in Portfolio Choice," Journal of Finance, American Finance Association, vol. 59(4), pages 1677-1716, 08. [Downloadable!] (restricted)
  33. Devereux, Michael B & Sutherland, Alan, 2006. "Solving for Country Portfolios in Open Economy Macro Models," CEPR Discussion Papers 5966, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  34. Stijn Van Nieuwerburgh & Laura Veldkamp, 2007. "Information Immobility and the Home Bias Puzzle," NBER Working Papers 13366, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  35. Cédric Tille & Eric van Wincoop, 2007. "International capital flows," Staff Reports 280, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  36. Michaelides, Alexander, 2003. "International portfolio choice, liquidity constraints and the home equity bias puzzle," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 555-594, December. [Downloadable!] (restricted)
    Other versions:
  37. Coeurdacier, Nicolas & Guibaud, Stéphane, 2006. "A Dynamic Equilibrium Model of Imperfectly Integrated Financial Markets," ESSEC Working Papers DR 06014, ESSEC Research Center, ESSEC Business School. [Downloadable!]
  38. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 745-75, August. [Downloadable!] (restricted)
    Other versions:
  39. Coeurdacier, Nicolas, 2006. "Do Trade Costs in Goods Market Lead to Home Bias in Equities?," ESSEC Working Papers DR 06011, ESSEC Research Center, ESSEC Business School. [Downloadable!]
  40. Bottazzi, Laura & Pesenti, Paolo & van Wincoop, Eric, 1996. "Wages, profits and the international portfolio puzzle," European Economic Review, Elsevier, vol. 40(2), pages 219-254, February. [Downloadable!] (restricted)
  41. Heathcote, Jonathan & Perri, Fabrizio, 2004. "Financial globalization and real regionalization," Journal of Economic Theory, Elsevier, vol. 119(1), pages 207-243, November. [Downloadable!] (restricted)
    Other versions:
  42. Christian Julliard, 2003. "The international diversification puzzle is not worse than you think," International Finance 0301004, EconWPA. [Downloadable!]
Full references

Cited by:
(explanations, 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.)

  1. Akito Matsumoto, 2007. "The Role of Nonseparable Utility and Nontradeables in International Business Cycle and Portfolio Choice," IMF Working Papers 07/163, International Monetary Fund. [Downloadable!]
  2. Eric van Wincoop & Francis E. Warnock, 2006. "Is Home Bias in Assets Related to Home Bias in Goods?," NBER Working Papers 12728, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Andrea Raffo, 2006. "Net exports, consumption volatility, and international real business cycle models," Research Working Paper RWP 06-01, Federal Reserve Bank of Kansas City. [Downloadable!]
    Other versions:
  4. Nicolas Coeurdacier & Pierre-Olivier Gourinchas, 2008. "When bonds matter: home bias in goods and assets," Working Paper Series 2008-25, Federal Reserve Bank of San Francisco. [Downloadable!]
  5. Pierre-Olivier Gourinchas, 2006. "The Research Agenda: Pierre-Olivier Gourinchas on Global Imbalances and Financial Factors," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 7(2), April. [Downloadable!]
  6. Tobias Broer, 2008. "The home bias of the poor: terms of trade effects and portfolios across the wealth distribution," Economics Working Papers ECO2008/28, European University Institute. [Downloadable!]
  7. Harald Hau & Helene Rey, 2008. "Home Bias at the Fund Level," NBER Working Papers 14172, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Coeurdacier, Nicolas & Kollmann, Robert Miguel W. K. & Martin, Philippe J., 2008. "International portfolios, capital accumulation and foreign assets dynamics," Discussion Paper Series 1: Economic Studies 2008,19, Deutsche Bundesbank, Research Centre. [Downloadable!]
    Other versions:
  9. Martin D. D. Evans & Viktoria Hnatkovska, 2005. "Solving General Equilibrium Models with Incomplete Markets and Many Assets," NBER Technical Working Papers 0318, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  10. Fabrice Collard & Harris Dellas & Behzad Diba & Alan Stockman, 2007. "Goods Trade and International Equity Portfolios," NBER Working Papers 13612, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Michael B. Devereux & Alan Sutherland, 2008. "Country portfolios in open economy macro models," Globalization and Monetary Policy Institute Working Paper 09, Federal Reserve Bank of Dallas. [Downloadable!]
    Other versions:
  12. Cedric Tille, 2005. "Financial integration and the wealth effect of exchange rate fluctuations," Staff Reports 226, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  13. Cédric Tille & Eric van Wincoop, 2007. "International capital flows," Staff Reports 280, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  14. Fabio Ghironi & Jaewoo Lee & Alessandro Rebucci, 2007. "The Valuation Channel of External Adjustment," NBER Working Papers 12937, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  15. Devereux, Michael B & Saito, Makoto, 2006. "A Portfolio Theory of International Capital Flows," CEPR Discussion Papers 5746, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  16. Martin D. D. Evans & Viktoria Hnatkovska, 2005. "International Capital Flows, Returns and World Financial Integration," NBER Working Papers 11701, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  17. Viktoria Hnatkovska & Martin Evans, 2005. "International Capital Flows in a World of Greater Financial Integration," Computing in Economics and Finance 2005 419, Society for Computational Economics. [Downloadable!]
  18. Charles Engel & Akito Matsumoto, 2005. "Portfolio Choice in a Monetary Open-Economy DSGE Model," IMF Working Papers 05/165, International Monetary Fund. [Downloadable!]
    Other versions:
  19. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
Statistics
Access and download statistics

Did you know? IDEAS also computes impact factors for journals and working paper series.

This page was last updated on 2009-6-25.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.