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Trying to Explain Home Bias in Equities and Consumption

  • Karen K. Lewis
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    Investors hold a substantially larger proportion of their wealth portfolios in domestic assets than standard portfolio theory would suggest, a phenomenon called "equity home bias." In the absence of this bias, investors would optimally diversify domestic output risk using foreign equities. Therefore, consumption growth rates would tend to co-move across countries even when output growth rates do not. Empirically, however, consumption growth rates tend to have a lower correlation across countries than do output growth rates, a phenomenon I call "consumption home bias." In this paper, I discuss these two biases and their potential relationship as suggested by the literature.

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    Article provided by American Economic Association in its journal Journal of Economic Literature.

    Volume (Year): 37 (1999)
    Issue (Month): 2 (June)
    Pages: 571-608

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    Handle: RePEc:aea:jeclit:v:37:y:1999:i:2:p:571-608
    Note: DOI: 10.1257/jel.37.2.571
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    1. Bekaert, Geert, 1994. "Exchange rate volatility and deviations from unbiasedness in a cash-in-advance model," Journal of International Economics, Elsevier, vol. 36(1-2), pages 29-52, February.
    2. 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.
    3. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
    4. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
    5. Larry R. Gorman & Bjorn N. Jorgensen, 2002. "Domestic versus International Portfolio Selection: A Statistical Examination of the Home Bias," Multinational Finance Journal, Multinational Finance Journal, vol. 6(3-4), pages 131-166, September.
    6. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
    7. Chris I. Telmer, 1991. "Asset Pricing Puzzles and Incomplete Markets," Working Papers 806, Queen's University, Department of Economics.
    8. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-79, June.
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