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Understanding International Portfolio Diversification and Turnover Rates

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  • Amir Amadi
  • Paul Bergin

Abstract

This paper argues that fixed trading costs in international asset markets help explain equity home bias. This contrasts with explanations prevalent in international macroeconomics, which tend to be based on trading frictions instead in international goods markets, such as nontraded goods or transportation costs. While the stylized fact of high trading turnover in foreign holdings has been interpreted as evidence against international asset trading costs, we show that this argument only applies to costs that are proportional to trade, and not to fixed costs of entering the foreign market. After documenting that the home bias and turnover stylized facts remain valid in recent data, the paper constructs a very simple portfolio allocation model with various configurations of trading costs and with heterogeneous types of traders. A configuration with per unit costs heterogeneous among agents and a homogeneous fixed cost is found to replicate the pair of stylized facts. Intuitively, the lower trading costs that characterize larger and more efficient traders have two implications: firstly, these traders find it more profitable to enter foreign markets; secondly, their lower trading costs encourage a higher rate of trading turnover. Since holdings of international equities are disproportionately dominated by this class of larger and more efficient traders, average trading turnover is higher among international holdings.

Suggested Citation

  • Amir Amadi & Paul Bergin, 2006. "Understanding International Portfolio Diversification and Turnover Rates," NBER Working Papers 12473, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12473 Note: IFM
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    References listed on IDEAS

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    1. Francis E. Warnock, 2001. "Home bias and high turnover reconsidered," International Finance Discussion Papers 702, Board of Governors of the Federal Reserve System (U.S.).
    2. Gian Maria Milesi-Ferretti, & Philip R. Lane, 2003. "International Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp03, IIIS.
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    14. Joshua Aizenman, 1999. "International Portfolio Diversification with Generalized Expected Utility Preferences," Canadian Journal of Economics, Canadian Economics Association, vol. 32(4), pages 995-1008, August.
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    18. Pesenti, Paolo & van Wincoop, Eric, 2002. "Can Nontradables Generate Substantial Home Bias?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 25-50, February.
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    Cited by:

    1. Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108-1159.
    2. Geromichalos, Athanasios & Simonovska, Ina, 2014. "Asset liquidity and international portfolio choice," Journal of Economic Theory, Elsevier, vol. 151(C), pages 342-380.
    3. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    4. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," Journal of Economic Literature, American Economic Association, pages 63-115.
    5. Hnatkovska, Viktoria, 2010. "Home bias and high turnover: Dynamic portfolio choice with incomplete markets," Journal of International Economics, Elsevier, pages 113-128.
    6. Kapteyn, Arie & Teppa, Federica, 2011. "Subjective measures of risk aversion, fixed costs, and portfolio choice," Journal of Economic Psychology, Elsevier, vol. 32(4), pages 564-580, August.
    7. Giofré, Maela, 2017. "Financial education, investor protection and international portfolio diversification," Journal of International Money and Finance, Elsevier, pages 111-139.
    8. Roland Straub & Luca Dedola & Giovanni Lombardo, 2011. "Home bias and portfolio dynamics in a multi-country model," 2011 Meeting Papers 1037, Society for Economic Dynamics.
    9. Ni, Jinlan, 2009. "The effects of portfolio size on international equity home bias puzzle," International Review of Economics & Finance, Elsevier, vol. 18(3), pages 469-478, June.
    10. Christelis, Dimitris & Georgarakos, Dimitris, 2013. "Investing at home and abroad: Different costs, different people?," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 2069-2086.

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    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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