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Can trade costs in goods explain home bias in assets?

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  • van Wincoop, Eric
  • Warnock, Francis E.

Abstract

A debate has raged in the general equilibrium literature on the impact of trade costs on portfolio home bias. In all of these models there is a simple, easily observed covariance-variance ratio. We compute this term using data on real exchange rates and asset returns. The resulting portfolio home bias is close to zero, implying that GE models that create home bias through trade costs are not grounded in empirical reality. Our results enable the GE literature to move forward, but in a way in which the theoretical models are not at odds with an easily observed empirical regularity.

Suggested Citation

  • van Wincoop, Eric & Warnock, Francis E., 2010. "Can trade costs in goods explain home bias in assets?," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1108-1123, October.
  • Handle: RePEc:eee:jimfin:v:29:y:2010:i:6:p:1108-1123
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    Cited by:

    1. Joseph Steinberg, 2018. "International Portfolio Diversification and the Structure of Global Production," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 29, pages 195-219, July.
    2. Coeurdacier, Nicolas & Gourinchas, Pierre-Olivier, 2016. "When bonds matter: Home bias in goods and assets," Journal of Monetary Economics, Elsevier, vol. 82(C), pages 119-137.
    3. John D. Burger & Francis E. Warnock & Veronica Cacdac Warnock, 2017. "Currency Matters: Analyzing International Bond Portfolios," NBER Working Papers 23175, National Bureau of Economic Research, Inc.
    4. Körner, Finn Marten & Trautwein, Hans-Michael, 2015. "Sovereign credit ratings and the transnationalization of finance: Evidence from a gravity model of portfolio investment," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 9, pages 1-54.
    5. Andreas Stathopoulos, 2012. "Portfolio Home Bias and External Habit Formation," 2012 Meeting Papers 502, Society for Economic Dynamics.
    6. Heathcote, Jonathan & Perri, Fabrizio, 2014. "Assessing International Efficiency," Handbook of International Economics, Elsevier.
    7. Okawa, Yohei & van Wincoop, Eric, 2012. "Gravity in International Finance," Journal of International Economics, Elsevier, vol. 87(2), pages 205-215.
    8. Diyarbakirlioglu, Erkin, 2011. "Foreign equity flows and the “Size Bias”: Evidence from an emerging stock market," Emerging Markets Review, Elsevier, vol. 12(4), pages 485-509.
    9. Christoph Böhringer, 2013. "Two Decades of European Climate Policy: A Critical Appraisal," ZenTra Working Papers in Transnational Studies 21 / 2013, ZenTra - Center for Transnational Studies, revised Nov 2013.
    10. Cooper, Ian & Sercu, Piet & Vanpée, Rosanne, 2013. "The Equity Home Bias Puzzle: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 7(4), pages 289-416, December.
    11. Erkin Diyarbakirlioglu, 2011. "Foreign equity flows and the "Size Bias" : Evidence from an emerging stock market," Post-Print hal-01127657, HAL.

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    Keywords

    Portfolio home bias Trade costs;

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