Working Paper: NBER ID: w23363
Authors: Philippe Bacchetta; Eric van Wincoop
Abstract: Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio decisions is stochastic rather than fixed, leading to a smoother response to shocks. Second, rather than only considering asset returns, we also use data on portfolio shares to confront the model to the data. Conditional on reasonable risk aversion, we find that the data is consistent with infrequent portfolio decisions, with a frequency of at most once in 15 months on average.
Keywords: portfolio adjustment; global equity; expected returns; capital flows
JEL Codes: F30; F41; G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| infrequent portfolio adjustments (G11) | larger equilibrium expected return differentials (D50) |
| gradual portfolio adjustment (G11) | weaker immediate portfolio response to shocks (G19) |
| weaker immediate portfolio response to shocks (G19) | larger expected return differentials in equilibrium (D53) |
| gradual portfolio adjustment (G11) | sensitivity of portfolios to expected returns (G11) |
| financial shocks (F65) | affect capital flows less than expected (F32) |