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Relative Factor Endowments and International Portfolio Choice

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  • Alejandro Cuñat
  • Christian Fons-Rosen

Abstract

This paper presents a model of international portfolio choice based on cross-country differences in relative factor abundance. Countries have varying degrees of similarity in their factor endowment ratios, and are subject to aggregate productivity shocks. Risk averse consumers can insure against these shocks by investing their wealth at home and abroad. In a many-good setup, the change in relative prices after a positive shock in a particular country provides insurance to countries that have dissimilar factor endowment ratios, but is bad news for countries with similar factor endowment ratios, since their incomes will worsen. Therefore countries with similar relative factor endowments have a stronger incentive to invest in one another for insurance purposes than countries with dissimilar endowments. Empirical evidence linking bilateral international investment positions to a proxy for relative factor endowments supports our theory: the similarity of host and source countries in their relative capital-labor ratios has a positive effect on the source country's investment position in the host country. The effect of similarity is enhanced by the size of host countries as predicted by the theory.

Suggested Citation

  • Alejandro Cuñat & Christian Fons-Rosen, 2008. "Relative Factor Endowments and International Portfolio Choice," CEP Discussion Papers dp0879, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp0879
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    References listed on IDEAS

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    Cited by:

    1. Alejandro Cuñat & Robert Zymek, 2017. "Specialization Patterns, GDP Correlations, and External Balances," CESifo Economic Studies, CESifo, vol. 63(2), pages 141-161.

    More about this item

    Keywords

    international portfolio equity investment; gravity equation; factor endowments;

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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