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The International Diversification Puzzle is Worse than you Think

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  • Baxter, M.
  • Jermann, U.J.

Abstract

Despite the growing integration of international financial markets, investors do not diversify internationally to any significant extent. The authors show that this 'international diversification puzzle' is deepened once they consider the implications of nontraded human capital for portfolio composition. While growth rates of labor and capital income are not highly correlated within countries, the authors find that the returns to human capital and physical capital are very highly correlated within four OECD countries. Hedging human capital risk therefore involves a substantial short position in domestic marketable assets. A diversified world portfolio will involve a negative position in domestic marketable assets. Copyright 1997 by American Economic Association.

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Bibliographic Info

Paper provided by University of Rochester - Center for Economic Research (RCER) in its series RCER Working Papers with number 350.

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Date of creation: 1993
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Handle: RePEc:roc:rocher:350

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Postal: University of Rochester, Center for Economic Research, Department of Economics, Harkness 231 Rochester, New York 14627 U.S.A.

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Keywords: trade policy;

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  1. N. Gregory Mankiw & Stephen P. Zeldes, 1990. "The Consumption of Stockholders and Non-Stockholders," NBER Working Papers 3402, National Bureau of Economic Research, Inc.
  2. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 257-275, April.
  3. French, Kenneth R. & Poterba, James M., 1990. "Japanese and U.S. cross-border common stock investments," Journal of the Japanese and International Economies, Elsevier, vol. 4(4), pages 476-493, December.
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