IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

International portfolio choice, liquidity constraints and the home equity bias puzzle

Author Info

Listed author(s):
  • Michaelides, Alexander

Abstract

This paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversifiable labor income risk. Optimal portfolios are internationally diversified while positive correlation between domestic stock market returns and permanent labor income shocks can generate a complete portfolio specialization in foreign stocks. Nevertheless, either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium differential are sufficient to either deter households from participating in a foreign market or generate a substantial bias for home equities. The benefits of international diversification are limited because consumption fluctuations can be smoothed with a small amount of buffer stock saving, while exchange rate risk makes foreign investments less appealing to risk averse investors.

(This abstract was borrowed from another version of this item.)

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/pii/S0165-1889(03)00035-6
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 28 (2003)
Issue (Month): 3 (December)
Pages: 555-594

as
in new window

Handle: RePEc:eee:dyncon:v:28:y:2003:i:3:p:555-594
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

Keywords:

Other versions of this item:

Find related papers by JEL classification:
  • J1 - Labor and Demographic Economics - - Demographic Economics

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.:

as
in new window


  1. Christopher D. Carroll, 1997. "Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 1-55.
  2. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters,in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
  3. Portes, Richard & Rey, Helene, 2005. "The determinants of cross-border equity flows," Journal of International Economics, Elsevier, vol. 65(2), pages 269-296, March.
  4. Pischke, Jorn-Steffen, 1995. "Individual Income, Incomplete Information, and Aggregate Consumption," Econometrica, Econometric Society, vol. 63(4), pages 805-840, July.
  5. 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.
  6. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
  7. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
  8. Michael Haliassos & Alexander Michaelides, 2003. "Portfolio Choice and Liquidity Constraints," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 143-177, February.
  9. Luis M. Viceira, 2001. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," Journal of Finance, American Finance Association, vol. 56(2), pages 433-470, 04.
  10. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
  11. Joshua D. Coval & Tobias J. Moskowitz, 1999. "Home Bias at Home: Local Equity Preference in Domestic Portfolios," Journal of Finance, American Finance Association, vol. 54(6), pages 2045-2073, December.
  12. John Y. Campbell & João F. Cocco & Francisco J. Gomes & Pascal J. Maenhout, 2001. "Investing Retirement Wealth: A Life-Cycle Model," NBER Chapters,in: Risk Aspects of Investment-Based Social Security Reform, pages 439-482 National Bureau of Economic Research, Inc.
  13. George M. Constantinides & John B. Donaldson & Rajnish Mehra, 2002. "Junior Can't Borrow: A New Perspective on the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 117(1), pages 269-296.
  14. 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 170-180, March.
  15. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January.
  16. Brennan, Michael J & Cao, H Henry, 1997. " International Portfolio Investment Flows," Journal of Finance, American Finance Association, vol. 52(5), pages 1851-1880, December.
  17. Ahearne, Alan G. & Griever, William L. & Warnock, Francis E., 2004. "Information costs and home bias: an analysis of US holdings of foreign equities," Journal of International Economics, Elsevier, vol. 62(2), pages 313-336, March.
  18. 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.
  19. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-329, June.
  20. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, vol. 60(4), pages 668-675, September.
  21. MaCurdy, Thomas E., 1982. "The use of time series processes to model the error structure of earnings in a longitudinal data analysis," Journal of Econometrics, Elsevier, vol. 18(1), pages 83-114, January.
  22. Christopher D. Carroll & Lawrence H. Summers, 1991. "Consumption Growth Parallels Income Growth: Some New Evidence," NBER Chapters,in: National Saving and Economic Performance, pages 305-348 National Bureau of Economic Research, Inc.
  23. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  24. Heaton, John & Lucas, Deborah, 1997. "Market Frictions, Savings Behavior, And Portfolio Choice," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 76-101, January.
  25. Abowd, John M & Card, David, 1989. "On the Covariance Structure of Earnings and Hours Changes," Econometrica, Econometric Society, vol. 57(2), pages 411-445, March.
  26. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
  27. Sydney C. Ludvigson & Alexander Michaelides, 2001. "Does Buffer-Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?," American Economic Review, American Economic Association, vol. 91(3), pages 631-647, June.
  28. Bohn, Henning & Tesar, Linda L, 1996. "U.S. Equity Investment in Foreign Markets: Portfolio Rebalancing or Return Chasing?," American Economic Review, American Economic Association, vol. 86(2), pages 77-81, May.
  29. Heaton, John & Lucas, Deborah, 2000. "Portfolio Choice in the Presence of Background Risk," Economic Journal, Royal Economic Society, vol. 110(460), pages 1-26, January.
  30. Arthur B. Kennickell & Martha Starr-McCluer, 1994. "Changes in family finances from 1989 to 1992: evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 861-882.
  31. Harald Hau, 2001. "Location Matters: An Examination of Trading Profits," Journal of Finance, American Finance Association, vol. 56(5), pages 1959-1983, October.
  32. Gehrig, Thomas, 1993. " An Information Based Explanation of the Domestic Bias in International Equity Investment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(1), pages 97-109.
Full references (including those not matched with items on IDEAS)

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

as
in new window


Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Access and download statistics

When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:28:y:2003:i:3:p:555-594. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.