Working Paper: NBER ID: w17691
Authors: Nicolas Coeurdacier; Hélène Rey
Abstract: Home bias is a perennial feature of international capital markets. We review various explanations of this puzzling phenomenon highlighting recent developments in macroeconomic modelling that incorporate international portfolio choices in standard two-country general equilibrium models. We refer to this new literature as Open Economy Financial Macroeconomics. We focus on three broad classes of explanations: (i) hedging motives in frictionless financial markets (real exchange rate and non-tradable income risk), (ii) asset trade costs in international financial markets (such as transaction costs or differences in tax treatments between national and foreign assets), (iii) informational frictions and behavioural biases. Recent theories call for new portfolio facts beyond equity home bias. We present new evidence on crossborder asset holdings across different types of assets: equities, bonds and bank lending and new micro data on institutional holdings of equity at the fund level. These data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment.
Keywords: home bias; international capital markets; portfolio choice; financial globalization
JEL Codes: F21; F3; F32; F4; F41; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Hedging motives related to real exchange rate risk and nontradable income risk (F31) | Favoring local equities over foreign ones (F23) |
| Asset trade costs (G31) | Persistence of home bias in equity holdings (G41) |
| Hedging motives related to real exchange rate risk and nontradable income risk + Asset trade costs (G15) | Home bias in equity portfolios (G15) |