(Asymmetric) Trade Costs, Real Exchange Rate Hedging, and Equity Home Bias in a Multi-Country Model

2017 ◽  
Author(s):  
Ju Hyun Pyun
Keyword(s):  
Exchange Rate ◽  
Real Exchange Rate ◽  
Home Bias ◽  
Trade Costs ◽  
Equity Home Bias

scholarly journals Equity home bias and consumption-real exchange rate puzzles: A joint solution

2021 ◽  
Vol 8 (10) ◽  
pp. 59-76
Author(s):  
Dao Hoang Tuan ◽  
Keyword(s):  
Exchange Rate ◽  
Real Exchange Rate ◽  
Model Simulation ◽  
Home Bias ◽  
Labor Income ◽  
Strong Positive Correlation ◽  
Home Equity ◽  
Income Share ◽  
Equity Home Bias ◽  
Dynamic Stochastic

In a standard dynamic stochastic general equilibrium model with a complete asset market, home agents should hold a foreign equity biased portfolio to hedge the non-traded labor income risk, which contradicts home equity biased portfolios observed worldwide. As the labor income share increases, the degree of home bias should decrease because there is more incentive to hold foreign equity. In the data, there is not any evidence that the labor income share and the degree of home bias are negatively correlated. The standard model also predicts that the consumption differential-real exchange rate correlation is positive, while it is negative in the data. I show that a combination of market incompleteness, non-tradable goods, and labor supply can explain the three features above. My model can generate a large equity home bias, despite the strong positive correlation of non-traded human capital return with domestic equity return. The home bias is not sensitive to the labor income share. The consumption differential-real exchange rate unconditional correlation generated by my model simulation is zero.

Home Bias in International Macroeconomics

2019 ◽  
Author(s):  
Viktoria Hnatkovska
Keyword(s):  
Exchange Rate ◽  
Home Bias ◽  
International Macroeconomics ◽  
World Market ◽  
Labor Income ◽  
Income Risk ◽  
Labor Income Risk ◽  
Equity Home Bias ◽  
The World ◽  
Over Time

Home bias in international macroeconomics refers to the fact that investors around the world tend to allocate majority of their portfolios into domestic assets, despite the potential benefits to be had from international diversification. This phenomenon has been occurring across countries, over time, and across equity or bond portfolios. The bias towards domestic assets tends to be larger in developing countries relative to developed economies, with Europe characterized by the lowest equity home bias, while Central and South America—by the highest equity home bias. In addition, despite the secular decline in the level of equity home bias over time in all countries and regions, home bias still remains a robust feature of the data. Whether home bias is a puzzle depends on the portfolio allocation that one uses as a theoretical benchmark. For instance, home bias in equity portfolio is a puzzle when assessed through the lens of a simple international capital asset pricing model (CAPM) with homogeneous investors. This model predicts that investors should hold world market portfolios, namely a portfolio with the share of domestic asset equal to the share of those assets in the world market portfolio. For instance, since the share of US equity in the world capitalization in 2016 was 56%, then US investors should allocate 56% of their equity portfolio into local assets, while investing the remaining 44% into foreign equities. Instead, foreign equity comprised just 23% of US equity portfolio in 2016, hence the equity home bias. Alternative portfolio benchmark comes from the theories that emphasize costs for trading assets in international financial markets. These include transaction and information costs, differential tax treatments, and more broadly, differences in institutional environments. This research, however, has so far been unable to reach a consensus on the explanatory power of such costs. Yet another theory argues that equity home bias can arise due to the hedging properties of local equity. In particular, local equity can provide insurance from real exchange rate risk and non-tradable income risk (such as labor income risk), and thus a preference towards home equities is not a puzzle, but rather an optimal response to such risks. These theories, main advances and results in the macroeconomic literature on home bias are discussed in this article. It starts by presenting some empirical facts on the extent and dynamics of equity home bias in developed and developing countries. It is then shown how home bias can arise as an equilibrium outcome of the hedging demand in the model with real exchange rate and non-tradable labor income risk. Since solving models with portfolio choice is challenging, the recent advances in solving such models are also outlined in this article. Integrating the portfolio dynamics into models that can generate realistic asset price and exchange rate dynamics remains a fruitful avenue for future research. A discussion of additional open questions in this research agenda and suggestions for further readings are also provided.

Sign in / Sign up

Export Citation Format

Share Document