IDEAS home Printed from https://ideas.repec.org/p/red/sed012/502.html
   My bibliography  Save this paper

Portfolio Home Bias and External Habit Formation

Author

Listed:
  • Andreas Stathopoulos

    (University of Southern California)

Abstract

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.

Suggested Citation

  • Andreas Stathopoulos, 2012. "Portfolio Home Bias and External Habit Formation," 2012 Meeting Papers 502, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:502
    as

    Download full text from publisher

    File URL: https://economicdynamics.org/meetpapers/2012/paper_502.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Riccardo Colacito & Mariano M. Croce, 2011. "Risks for the Long Run and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 153-181.
    2. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters,in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
    3. 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.
    4. Coeurdacier, Nicolas, 2009. "Do trade costs in goods market lead to home bias in equities?," Journal of International Economics, Elsevier, pages 86-100.
    5. Anna Pavlova & Roberto Rigobon, 2007. "Asset Prices and Exchange Rates," Review of Financial Studies, Society for Financial Studies, pages 1139-1180.
    6. Kang, Jun-Koo & Stulz, Rene M., 1997. "Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan," Journal of Financial Economics, Elsevier, vol. 46(1), pages 3-28, October.
    7. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, pages 571-608.
    8. Robert Kollmann, 2006. "A Dynamic Equilibrium Model of International Portfolio Holdings: Comment," Econometrica, Econometric Society, vol. 74(1), pages 269-273, January.
    9. van Wincoop, Eric & Warnock, Francis E., 2010. "Can trade costs in goods explain home bias in assets?," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1108-1123, October.
    10. repec:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
    11. Adrien Verdelhan, 2010. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Journal of Finance, American Finance Association, vol. 65(1), pages 123-146, February.
    12. Emmanuel Farhi & Xavier Gabaix, "undated". "Rare Disasters and Exchange Rates," Working Paper 71001, Harvard University OpenScholar.
    13. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    14. Hanno Lustig & Adrien Verdelhan, 2007. "The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk," American Economic Review, American Economic Association, pages 89-117.
    15. Baxter, Marianne & Jermann, Urban J. & King, Robert G., 1998. "Nontraded goods, nontraded factors, and international non-diversification," Journal of International Economics, Elsevier, pages 211-229.
    16. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, pages 3-24.
    17. Hanno Lustig & Adrien Verdelhan, 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2006-045, Boston University - Department of Economics.
    18. Angel Serrat, 2001. "A Dynamic Equilibrium Model of International Portfolio Holdings," Econometrica, Econometric Society, vol. 69(6), pages 1467-1489, November.
    19. Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2009. "Risk, uncertainty, and asset prices," Journal of Financial Economics, Elsevier, vol. 91(1), pages 59-82, January.
    20. Stockman, Alan C. & Dellas, Harris, 1989. "International portfolio nondiversification and exchange rate variability," Journal of International Economics, Elsevier, pages 271-289.
    21. Tesar, Linda L., 1993. "International risk-sharing and non-traded goods," Journal of International Economics, Elsevier, pages 69-89.
    22. Brandt, Michael W. & Cochrane, John H. & Santa-Clara, Pedro, 2006. "International risk sharing is better than you think, or exchange rates are too smooth," Journal of Monetary Economics, Elsevier, pages 671-698.
    23. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, pages 170-180.
    24. Moore, Michael J. & Roche, Maurice J., 2010. "Solving exchange rate puzzles with neither sticky prices nor trade costs," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 1151-1170, October.
    25. Brennan, Michael J & Cao, H Henry, 1997. " International Portfolio Investment Flows," Journal of Finance, American Finance Association, vol. 52(5), pages 1851-1880, December.
    26. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, pages 170-180.
    27. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2010. "International portfolios, capital accumulation and foreign assets dynamics," Journal of International Economics, Elsevier, pages 100-112.
    28. Black, Fischer, 1974. "International capital market equilibrium with investment barriers," Journal of Financial Economics, Elsevier, vol. 1(4), pages 337-352, December.
    29. Adrien Verdelhan & Hanno Lustig, 2005. "The Cross-Section Of Foreign Currency Risk Premia And Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2005-019, Boston University - Department of Economics.
    30. Andrea Buraschi & Alexei Jiltsov, 2007. "Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 62(6), pages 3009-3063, December.
    31. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-984, June.
    32. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, pages 335-359.
    33. Bekaert, Geert, 1996. "The Time Variation of Risk and Return in Foreign Exchange Markets: A General Equilibrium Perspective," Review of Financial Studies, Society for Financial Studies, pages 427-470.
    34. Lustig, H. & Verdelhan, A., 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Working papers 155, Banque de France.
    35. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g7084aa4m is not listed on IDEAS
    36. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
    37. Cevdet Aydemir, A., 2008. "Risk sharing and counter-cyclical variation in market correlations," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3084-3112, October.
    38. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 1.
    39. Uppal, Raman, 1993. " A General Equilibrium Model of International Portfolio Choice," Journal of Finance, American Finance Association, vol. 48(2), pages 529-553, June.
    40. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
    41. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
    42. G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003. "Handbook of the Economics of Finance," Handbook of the Economics of Finance, Elsevier, edition 1, volume 1, number 2.
    Full references (including those not matched with items on IDEAS)

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed012:502. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.