International portfolio choice, liquidity constraints and the home equity bias puzzle
✍ Scribed by Alexander Michaelides
- Publisher
- Elsevier Science
- Year
- 2003
- Tongue
- English
- Weight
- 526 KB
- Volume
- 28
- Category
- Article
- ISSN
- 0165-1889
No coin nor oath required. For personal study only.
✦ Synopsis
This paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversiÿable labor income risk. Optimal portfolios are internationally diversiÿed while positive correlation between domestic stock market returns and permanent labor income shocks can generate a complete portfolio specialization in foreign stocks. Nevertheless, either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium di erential are su cient to either deter households from participating in a foreign market or generate a substantial bias for home equities. The beneÿts of international diversiÿcation are limited because consumption uctuations can be smoothed with a small amount of bu er stock saving, while exchange rate risk makes foreign investments less appealing to risk averse investors.