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When bonds matter: home bias in goods and assets

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  • Nicolas Coeurdacier
  • Pierre-Olivier Gourinchas

    (University of California, Berkeley (Haas School of Business))

Abstract

Recent models of international equity portfolios exhibit two potential weaknesses. First, the structure of equilibrium equity portfolios is determined by the correlation of equity returns with real exchange rates and non financial income; yet empirically domestic equities don’t appear to be a good hedge against either risk factors; Second, equity portfolios are highly sensitive to preference parameters. This paper addresses both issues. It shows that in more general and realistic environments, (a) the hedging of real exchange rate risks occurs through international bond holdings, since relative bond returns are strongly correlated with real exchange rate fluctuations; (b) domestic equities can provide a good hedge against non-financial income risk, conditionally on bond returns. The model delivers equilibrium portfolios that are well-behaved as a function of the underlying preference parameters. Empirically, we find reasonable empirical support for the theory for G-7 countries. We are able to explain short positions in domestic currency bonds for all G-7 countries, as well as significant levels of home equity bias for the US, Japan and Canada.

Suggested Citation

  • Nicolas Coeurdacier & Pierre-Olivier Gourinchas, 2009. "When bonds matter: home bias in goods and assets," Sciences Po publications info:hdl:2441/c8dmi8nm4pd, Sciences Po.
  • Handle: RePEc:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g821o6lsg
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    References listed on IDEAS

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    Keywords

    International risk sharing; International portfolios; Home equity bias;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • 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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