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A Dynamic Equilibrium Model of International Portfolio Holdings

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  • Angel Serrat

Abstract

This paper develops a continuous-time equilibrium model of a two-country exchange economy with heterogeneous agents and nontraded goods. Nontraded goods play the role of state variables that shift the marginal utility of traded goods. This affects prices and generates dynamic hedging demands that explain the well documented home bias puzzle in international equity portfolios. When calibrated to both consumption and production data, the model is able to generate significative home bias in equity portfolios. A new methodology, based on Malliavin calculus, is presented to solve for the portfolio policies along the equilibrium path. This methodology allows one to reduce the determination of equilibrium portfolio holdings to the solution of a linear algebraic system, rather than a partial differential equation. Copyright The Econometric Society.

Suggested Citation

  • Angel Serrat, 2001. "A Dynamic Equilibrium Model of International Portfolio Holdings," Econometrica, Econometric Society, vol. 69(6), pages 1467-1489, November.
  • Handle: RePEc:ecm:emetrp:v:69:y:2001:i:6:p:1467-1489
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    References listed on IDEAS

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    1. 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 267-297, April.
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    7. Darrell Duffie & Chi-Fu Huang, 2005. "Implementing Arrow-Debreu Equilibria By Continuous Trading Of Few Long-Lived Securities," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 4, pages 97-127, World Scientific Publishing Co. Pte. Ltd..
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