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Hedging against the government: a solution to the home asset bias puzzle

  • Tiago C. Berriel
  • Saroj Bhattarai

This paper explains two puzzling facts: international nominal bonds and equity portfolios are biased domestically. In our two-country model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: some nominal risk and taxes falling only on domestic agents. A third feature explains why agents choose to hold primarily domestic equity: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. These conclusions are robust to a wide range of preference parameter values and the incompleteness of financial markets. A calibrated version of the model predicts asset holdings that quantitatively match the data.

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File URL: http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0113.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 113.

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Date of creation: 2012
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Handle: RePEc:fip:feddgw:113
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  1. Backus, David K & Kehoe, Patrick J, 1992. "International Evidence of the Historical Properties of Business Cycles," American Economic Review, American Economic Association, vol. 82(4), pages 864-88, September.
  2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2005. "International risk-sharing and the transmission of productivity shocks," International Finance Discussion Papers 826, Board of Governors of the Federal Reserve System (U.S.).
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  1. Hedging against the Government: A Solution to the Home Asset Bias Puzzle (AEJ:MA 2013) in ReplicationWiki

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