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Equity Home Bias in a Capital Market Union

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  • Markus Sihvonen

    (Bank of Finland, Research Unit, Snellmaninaukio)

Abstract

I study the social efficiency and aggregate effects of equity home bias using a general equilibrium model with nominal rigidities and a fixed exchange rate. I find that the source of home bias is key for analyzing the wedge between equilibrium and socially optimal levels of home bias. Surprisingly, when home bias is due to labor income hedging effects, stock positions tend to be approximately efficient despite the aggregate demand externalities induced by the rigidities. On the other hand, home stock positions are excessive when home bias is due to financial frictions or biased expectations. The key theoretical results hold numerically well in a more general quantitative model.

Suggested Citation

  • Markus Sihvonen, 2023. "Equity Home Bias in a Capital Market Union," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 71(4), pages 953-999, December.
    • Handle: RePEc:pal:imfecr:v:71:y:2023:i:4:d:10.1057_s41308-023-00197-9
    DOI: 10.1057/s41308-023-00197-9
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