OPTIMAL INTERNATIONAL ASSET ALLOCATION WITH TIME‐VARYING RISK

Thomas Flavin and Michael Wickens

Scottish Journal of Political Economy, 2006, vol. 53, issue 5, 543-564

Abstract: This paper examines the optimal allocation each period of an internationally diversified portfolio from the different points of view of a UK and a US investor. We find that investor location affects optimal asset allocation. The presence of exchange rate risk causes the markets to appear not fully integrated and creates a preference for home assets. Domestic equity is the dominant asset in the optimal portfolio for both investors, but the US investor bears less risk than the UK investor, and holds less foreign equity – 20% compared with 25%. Survey evidence indicates actual shares are 6% and 18%, respectively, making the home‐bias puzzle more acute for US than UK investors. There would seem to be more potential gains from increased international diversification for the US than the UK investor.

Date: 2006
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https://doi.org/10.1111/j.1467-9485.2006.00394.x

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