International Portfolio Choice, Liquidity Constraints and the Home Equity Bias Puzzle
37 Pages Posted: 30 Nov 2001
There are 2 versions of this paper
International Portfolio Choice, Liquidity Constraints and the Home Equity Bias Puzzle
Date Written: November 2001
Abstract
This Paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversifiable labour income risk. Optimal portfolios are internationally diversified while positive correlation between domestic stock market returns and permanent labour income shocks can worsen the home equity bias puzzle. Nevertheless, either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium differential are sufficient to either deter households from participating in a foreign market or generate a substantial bias for home equities. The benefits of international diversification are limited because consumption fluctuations can be smoothed with a small amount of buffer stock saving, while exchange rate risk makes foreign investments less appealing to risk averse investors.
Keywords: International portfolio choice, home equity bias, liquidity constraints, information costs
JEL Classification: E20, G11
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
The Impact of Exchange Rate Movements on U.S. Foreign Debt
By Cédric Tille
-
An Equilibrium Model of Global Imbalances and Low Interest Rates
By Ricardo J. Caballero, Emmanuel Farhi, ...
-
An Equilibrium Model of "Global Imbalances" and Low Interest Rates
By Ricardo J. Caballero, Emmanuel Farhi, ...