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Asset Liquidity and International Portfolio Choice

  • Ina Simonovska

    (University of California, Davis)

  • Athanasios Geromichalos

    (University of California, Davis)

We study optimal asset portfolio choice in a two-country search-theoretic model of monetary exchange. We allow assets to not only represent claims on future consumption, but to also serve as means of payment. Assuming foreign assets trade at a cost, we characterize equilibria in which different countries’ assets arise as media of exchange in different types of trades. More frequent trading opportunities at home result in agents holding proportionately more domestic over foreign assets. Consequently, agents have larger claims to domestic over foreign consumption goods. Moreover, foreign assets turn over faster than home assets because the former have desirable liquidity properties, but unfavorable returns over time. Our mechanism offers an answer to a long-standing puzzle in international finance: a positive relationship between consumption and asset home bias, coupled with higher turnover rates of foreign over domestic assets.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 756.

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Date of creation: 2011
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Handle: RePEc:red:sed011:756
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Web page: http://www.EconomicDynamics.org/society.htmEmail:


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  1. Ricardo Lagos & Guillaume Rocheteau, 2006. "Money and capital as competing media of exchange," Working Paper 0608, Federal Reserve Bank of Cleveland.
  2. Jonathan Heathcote & Fabrizio Perri, 2007. "The international diversification puzzle is not as bad as you think," Staff Report 398, Federal Reserve Bank of Minneapolis.
  3. Camera, Gabriele & Winkler, Johannes, 2003. "International monetary trade and the law of one price," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1531-1553, October.
  4. Kiminori Matsuyama, 1991. "Toward a Theory of International Currency," Discussion Papers 931, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Head, Allen & Shi, Shouyong, 2003. "A fundamental theory of exchange rates and direct currency trades," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1555-1591, October.
  6. Fabrice Collard & Harris Dellas & Behzad Diba & Alan Stockman, 2009. "Goods Trade and International Equity Portfolios," School of Economics Working Papers 2009-14, University of Adelaide, School of Economics.
  7. Hnatkovska, Viktoria, 2010. "Home bias and high turnover: Dynamic portfolio choice with incomplete markets," Journal of International Economics, Elsevier, vol. 80(1), pages 113-128, January.
  8. Benjamin Lester & Andrew Postlewaite & Randall Wright, 2008. "Information, Liquidity and Asset Prices," PIER Working Paper Archive 08-039, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  9. Athanasios Geromichalos & Juan M Licari & Jose Suarez-Lledo, 2007. "Monetary Policy and Asset Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(4), pages 761-779, October.
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