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Cross-Border Portfolio Diversification under Trade Linkages

Author

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  • Makram Khalil

    (Deutsche Bundesbank)

Abstract

This study uncovers a cross-border financial diversification motive related to goods and services trade. Using the IMF CPIS panel data set for a broad set of country pairs and for the period 2001-2012, I find empirical evidence that the share of equity in a bilateral portfolio decreases with bilateral trade. An important driving force behind this pattern are holdings of foreign debt, i.e. increasing trade intensity is strongly related to increasing holdings of foreign debt and less so to holdings of foreign equity. The empirical findings are in line with the predictions of a calibrated two-country two-goods portfolio choice model where in equilibrium equity is used to hedge against supply shocks and real bonds are used to hedge against a global preference shock. For reasonable parameter values, strengthening trade linkages induce the risk-averse representative agent to adjust her portfolio of foreign assets away from foreign equity and towards foreign bonds.

Suggested Citation

  • Makram Khalil, 2017. "Cross-Border Portfolio Diversification under Trade Linkages," MNB Working Papers 2017/2, Magyar Nemzeti Bank (Central Bank of Hungary).
    • Handle: RePEc:mnb:wpaper:2017/2
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    Cited by:

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    2. Guillermo Hausmann-Guil, 2025. "Solving DSGE models with incomplete markets by perturbation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 57, July.
    3. Bouraima Sawadogo & Constant Fouopi Djiogap & Idrissa Ouedraogo & Moukaila Mouzamilou Takpara, 2024. "An empirical assessment of the role of trade in services in export product diversification in Sub-Saharan Africa," Journal of Productivity Analysis, Springer, vol. 61(3), pages 229-257, June.
    4. Haoyuan Ding & Xiao Li & Jiezhou Ying, 2023. "Anti‐dumping Policies and International Portfolio Allocation: The View from the Global Funds," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 31(2), pages 58-83, March.

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    Keywords

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    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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