Infrequent Random Portfolio Decisions in an Open Economy Model

Philippe Bacchetta, Eric van Wincoop and Eric Young

The Review of Economic Studies, 2023, vol. 90, issue 3, 1125-1154

Abstract: We introduce a portfolio friction in a two-country DSGE model where investors face a constant probability to make new portfolio decisions. The friction leads to a more gradual portfolio adjustment to shocks and a weaker portfolio response to changes in expected excess returns. We apply the model to monthly data for the US and the rest of the world for equity portfolios. We show that the model is consistent with a broad set of evidence related to portfolios, equity prices, and excess returns for an intermediate level of friction. The evidence includes portfolio inertia, limited sensitivity to expected excess returns, a significant impact of financial shocks, excess return predictability, and asset price momentum and reversal.

Keywords: Portfolio frictions; Infrequent portfolio decisions; International portfolio allocation; Excess return predictability; Financial shocks; F30; F41; G11; G12 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:90:y:2023:i:3:p:1125-1154.

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