Consumption hedging and home-country bias in a model of international capital market equilibrium
Purpose – The purpose of this paper is to develop a model of international capital market equilibrium where investors exhibit home-country bias due to their desire to hedge real consumption. Design/methodology/approach – This paper posits a two-stage process of portfolio choice for the representative investor of a country. In the first step, the investor's benchmark portfolio is determined, whereas in the second step, his optimal portfolio is chosen. The latter portfolio maximizes the expected portfolio rate of return minus the risk tolerance weighted variance of tracking error. The market equilibrium implications of the portfolio optimality conditions are determine via aggregation across all investors and countries. Findings – A revised security market line is derived that differs from the traditional security market line in terms of vertical intercept, slope, and beta coefficient. It is demonstrated that the derived model may be interpreted as a multi-country generalization of the Chen-Boness extension of the capital asset pricing model under uncertain inflation. Originality/value – This paper presents an innovative application of Roll's tracking portfolio paradigm. Another novel feature is the derivation of the international capital market equilibrium implications of such portfolio choice behaviour.
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Volume (Year): 29 (2012)
Issue (Month): 1 (March)
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References listed on IDEAS
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Working Papers Department of Economics
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International Finance Discussion Papers
691, Board of Governors of the Federal Reserve System (U.S.).
- 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.
- Kang, Jun-Koo & Stulz, Rene M., 1997.
"Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan,"
Journal of Financial Economics,
Elsevier, vol. 46(1), pages 3-28, October.
- Jun-Koo Kang & Rene M. Stulz, 1995. "Why Is There a Home Bias? An Analysis of Foreign Portfolio Equity Ownership in Japan," NBER Working Papers 5166, National Bureau of Economic Research, Inc.
- 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.
- Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-34, September.
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