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Infrequent Random Portfolio Decisions in an Open Economy Model

Author

Listed:
  • Philippe Bacchetta

    (University of Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute)

  • Eric van Wincoop

    (University of Virginia - Department of Economics; National Bureau of Economic Research (NBER))

  • Eric R. Young

    (University of Virginia)

Abstract

We introduce a portfolio friction in a two-country DSGE model where investors face a constant probability to make new portfolio decisions. The friction leads to a more gradual portfolio adjustment to shocks and a weaker portfolio response to changes in expected excess returns. We apply the model to monthly data for the US and rest of the world for equity portfolios. We show that the model is consistent with a broad set of evidence related to portfolios, equity prices and excess returns for an intermediate level of the friction. The evidence includes portfolio inertia, limited sensitivity to expected excess returns, a significant impact of financial shocks, excess return predictability, and asset price momentum and reversal.

Suggested Citation

  • Philippe Bacchetta & Eric van Wincoop & Eric R. Young, 2022. "Infrequent Random Portfolio Decisions in an Open Economy Model," Swiss Finance Institute Research Paper Series 22-10, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2210
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    Cited by:

    1. Bacchetta, Philippe & Davenport, Margaret & van Wincoop, Eric, 2022. "Can sticky portfolios explain international capital flows and asset prices?," Journal of International Economics, Elsevier, vol. 136(C).

    More about this item

    Keywords

    portfolio frictions; infrequent portfolio decisions; international portfolio allocation; excess return predictability; financial shocks.;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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