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Portfolio Allocation and International Risk Sharing

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  • Gianluca Benigno
  • Hande Küçük-Tuger

Abstract

Recent contributions have shown that it is possible to account for the so-called consumption-real exchange anomaly in models with goods market frictions where international asset trade is limited to a riskless bond. In this paper, we consider a more realistic international asset market structure and show that as soon as we depart from the single bond economy, we can no longer account for the consumption-real exchange anomaly. Our central result holds for a simple asset market structure in which two nominal bonds are traded across countries. We explore the role of demand shocks such as news shocks in generating meaningful market incompleteness. We show that only under specific settings news shocks can improve the performance of the model in matching the portfolio positions and consumption-real exchange rate correlations that we observe in the data.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1048.

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Date of creation: Apr 2011
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Handle: RePEc:cep:cepdps:dp1048
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

Keywords: Portfolio choice; incomplete financial markets; international risk sharing; consumption-real exchange rate anomaly;

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Find related papers by JEL classification:
  • F31 - International Economics - - International Finance - - - Foreign Exchange
  • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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Cited by:

  1. Matthew Canzoneri & Robert Cumby & Behzad Diba, 2013. "Addressing International Empirical Puzzles: the Liquidity of Bonds," Open Economies Review, Springer, vol. 24(2), pages 197-215, April.
  2. Emmanuel Farhi & Gita Gopinath & Oleg Itskhoki, . "Fiscal Devaluations," Working Paper 70976, Harvard University OpenScholar.
  3. Karabarbounis, Loukas, 2010. "Labor wedges and open economy puzzles," MPRA Paper 31370, University Library of Munich, Germany.
  4. Küçük, Hande & Sutherland, Alan, 2015. "International Risk Sharing and Portfolio Choice with Non-separable Preferences," CEPR Discussion Papers 10724, C.E.P.R. Discussion Papers.
  5. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  6. Devereux, Michael B. & Kollmann, Robert, 2012. "International Risk Sharing," MPRA Paper 70129, University Library of Munich, Germany.
  7. Caporale, Guglielmo Maria & Donadelli, Michael & Varani, Alessia, 2015. "International capital markets structure, preferences and puzzles: A “US–China World”," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 36(C), pages 85-99.
  8. Donadelli, Michael & Paradiso, Antonio, 2014. "Does financial integration affect real exchange rate volatility and cross-country equity market returns correlation?," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 206-220.

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