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The home bias of the poor: terms of trade effects and portfolios across the wealth distribution

  • Tobias Broer
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    Wealthier people generally hold a larger part of their savings in risky assets. Using the US Survey of Consumer Finances, I show that wealthier households also have a higher portfolio share of foreign assets. This relative home bias of the poor does not seem to be explained by fixed participation costs alone, as the portfolio share of foreign assets increases with financial wealth even among participants in foreign asset markets. This paper shows how both biases of poorer agents' portfolios, towards safe and home assets, can arise in a simple 2 country economy with income and portfolio heterogeneity. Poor investors are naturally biased against domestic equity when wages and capital returns are positively correlated, making equity a bad hedge against fluctuations in labour income relative to bonds. Moreover poor investors prefer home to foreign bonds if equilibrium terms of trade movements systematically lead to a fall in the purchasing power of domestic assets in periods of high wages. I show that this is likely to be the case if aggregate supply shocks at home are more important than abroad. Finally, the model shows that aggregate home bias in the country portfolio implies relative home bias of the poor and vice versa.

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    Paper provided by European University Institute in its series Economics Working Papers with number ECO2008/28.

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    Date of creation: 2008
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    Handle: RePEc:eui:euiwps:eco2008/28
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    1. Harald Uhlig, 1996. "A law of large numbers for large economies (*)," Economic Theory, Springer, vol. 8(1), pages 41-50.
    2. Guiso, Luigi & Jappelli, Tullio, 2000. "Household Portfolios in Italy," CEPR Discussion Papers 2549, C.E.P.R. Discussion Papers.
    3. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
    4. Fabrizio Perri & Jonathan Heathcote, 2007. "The International Diversification Puzzle Is Not as Bad as You Think," Working Papers 2007-3, University of Minnesota, Department of Economics, revised 08 Oct 2007.
    5. Calvet, Laurent & Campbell, John Y. & Sodini, Paolo, 2006. "Down or out: assessing the welfare costs of household investment mistakes," Les Cahiers de Recherche 832, HEC Paris.
    6. Eric van Wincoop & Francis E. Warnock, 2006. "Is Home Bias in Assets Related to Home Bias in Goods?," NBER Working Papers 12728, National Bureau of Economic Research, Inc.
    7. Guiso, Luigi & Haliassos, Michalis & Jappelli, Tullio, 2003. "Household Stockholding in Europe: Where Do We Stand, and Where Do We Go?," CEPR Discussion Papers 3694, C.E.P.R. Discussion Papers.
    8. Heckman, James J, 1979. "Sample Selection Bias as a Specification Error," Econometrica, Econometric Society, vol. 47(1), pages 153-61, January.
    9. Christopher D. Carroll, 2000. "Portfolios of the Rich," NBER Working Papers 7826, National Bureau of Economic Research, Inc.
    10. Campbell, John, 2006. "Household Finance," Scholarly Articles 3157877, Harvard University Department of Economics.
    11. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
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