The home bias of the poor: terms of trade effects and portfolios across the wealth distribution

Tobias Broer

No ECO2008/28, Economics Working Papers from European University Institute

Abstract: Wealthier people generally hold a larger part of their savings in risky assets. Using the US Survey of Consumer Finances, I show that wealthier households also have a higher portfolio share of foreign assets. This relative home bias of the poor does not seem to be explained by fixed participation costs alone, as the portfolio share of foreign assets increases with financial wealth even among participants in foreign asset markets. This paper shows how both biases of poorer agents' portfolios, towards safe and home assets, can arise in a simple 2 country economy with income and portfolio heterogeneity. Poor investors are naturally biased against domestic equity when wages and capital returns are positively correlated, making equity a bad hedge against fluctuations in labour income relative to bonds. Moreover poor investors prefer home to foreign bonds if equilibrium terms of trade movements systematically lead to a fall in the purchasing power of domestic assets in periods of high wages. I show that this is likely to be the case if aggregate supply shocks at home are more important than abroad. Finally, the model shows that aggregate home bias in the country portfolio implies relative home bias of the poor and vice versa.

Keywords: Heterogeneous Agents; Home Bias; Inequality; International Asset Diversification; Portfolio Choice (search for similar items in EconPapers)
JEL-codes: F36 G11 E21 D11 D31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
Date: 2008
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