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Do trade costs in goods market lead to home bias in equities?

  • Coeurdacier, Nicolas

Two of the main puzzles in international economics are the consumption and the portfolio home biases. We solve for international equity portfolios in a two-country/two-good stochastic equilibrium model with trade costs in goods markets. We show that introducing trade costs, as suggested by Obstfeld and Rogoff [Obstfeld, M., Rogoff, K., 2000a. The Six Major Puzzles in International Macroeconomics: Is There a Common Cause? NBER Macroeconomics Annual, 15], is not sufficient to explain these two puzzles simultaneously. On the contrary, we find that trade costs create a foreign bias in portfolios for reasonable parameter values. This result is robust to the addition of non-tradable goods for standard calibrations of the preferences.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 77 (2009)
Issue (Month): 1 (February)
Pages: 86-100

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Handle: RePEc:eee:inecon:v:77:y:2009:i:1:p:86-100
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