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Portfolio Home Bias and External Habit Formation

  • Andreas Stathopoulos

    (University of Southern California)

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    This paper explores international portfolio choice in a multi-country, multi-good general equilibrium setting which features time-varying risk aversion generated by external habit formation. It is shown that time variation in conditional risk aversion generates time variation in the countries' relative consumption expenditure. As a result, financing equilibrium consumption entails hedging against adverse fluctuations in risk aversion. In equilibrium, an increase in home risk aversion tends to appreciate the home equity and depreciate the foreign equity, so each agent hedges by shifting her equity portfolio towards the home equity claim. Furthermore, the model is able to generate realistic asset price and exchange rate dynamics, satisfying a long-standing need of the general equilibrium literature in international finance.

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    File URL: https://www.economicdynamics.org/meetpapers/2012/paper_502.pdf
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    Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 502.

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    Date of creation: 2012
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    Handle: RePEc:red:sed012:502
    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
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    Web page: http://www.EconomicDynamics.org/society.htm
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    1. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," International Trade 0012003, EconWPA.
    2. Maurice J. Roche & Michael J. Moore, 2009. "Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs," Working Papers 001, Ryerson University, Department of Economics.
    3. Adrien Verdelhan, 2006. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Computing in Economics and Finance 2006 217, Society for Computational Economics.
    4. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2010. "International portfolios, capital accumulation and foreign assets dynamics," Journal of International Economics, Elsevier, vol. 80(1), pages 100-112, January.
    5. Riccardo Colacito & Mariano Croce, 2005. "Risks For The Long Run And The Real Exchange Rate," 2005 Meeting Papers 794, Society for Economic Dynamics.
    6. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
    7. Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2006. "Risk, Uncertainty and Asset Prices," CEPR Discussion Papers 5947, C.E.P.R. Discussion Papers.
    8. Robert Kollmann, 2006. "A Dynamic Equilibrium Model of International Portfolio Holdings: Comment," Econometrica, Econometric Society, vol. 74(1), pages 269-273, 01.
    9. Lustig, H. & Verdelhan, A., 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Working papers 155, Banque de France.
    10. Stockman, Alan C. & Dellas, Harris, 1989. "International portfolio nondiversification and exchange rate variability," Journal of International Economics, Elsevier, vol. 26(3-4), pages 271-289, May.
    11. Emmanuel Farhi & Xavier Gabaix, 2008. "Rare Disasters and Exchange Rates," NBER Working Papers 13805, National Bureau of Economic Research, Inc.
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