Relative Factor Endowments and International Portfolio Choice

Alejandro Cunat and Christian Fons-Rosen

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: This paper presents a model of international portfolio choice based on cross-country differences in relative factor abundance. Countries have varying degrees of similarity in their factor endowment ratios, and are subject to aggregate productivity shocks. Risk averse consumers can insure against these shocks by investing their wealth at home and abroad. In a many-good setup, the change in relative prices after a positive shock in a particular country provides insurance to countries that have dissimilar factor endowment ratios, but is bad news for countries with similar factor endowment ratios, since their incomes will worsen. Therefore countries with similar relative factor endowments have a stronger incentive to invest in one another for insurance purposes than countries with dissimilar endowments. Empirical evidence linking bilateral international investment positions to a proxy for relative factor endowments supports our theory: the similarity of host and source countries in their relative capital-labor ratios has a positive effect on the source country's investment position in the host country. The effect of similarity is enhanced by the size of host countries as predicted by the theory.

Keywords: international portfolio equity investment; gravity equation; factor endowments (search for similar items in EconPapers)
JEL-codes: F21 F34 G11 (search for similar items in EconPapers)
Date: 2008-07
New Economics Papers: this item is included in nep-opm
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https://cep.lse.ac.uk/pubs/download/dp0879.pdf (application/pdf)

Related works:
Journal Article: RELATIVE FACTOR ENDOWMENTS AND INTERNATIONAL PORTFOLIO CHOICE (2013)
Working Paper: Relative Factor Endowments and International Portfolio Choice (2008)
Working Paper: Relative factor endowments and international portfolio choice (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:cep:cepdps:dp0879

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