The International Diversification Puzzle when Goods Prices Are Sticky: It's Really About Exchange-Rate Hedging, not Equity Portfolios

Akito Matsumoto and Charles Engel

No 2009/012, IMF Working Papers from International Monetary Fund

Abstract: This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some nominal goods prices are sticky. Trade in these assets achieves the same allocations as trade in a complete set of nominal state-contingent claims in our linearized model. When there is a high degree of price stickiness, we show that not much equity diversification is required to replicate the complete-markets equilibrium when agents are able to hedge foreign exchange risk sufficiently. Moreover, temporarily sticky nominal goods prices can have large effects on equity portfolios even when dividend processes are very persistent.

Keywords: WP; exchange rate; optimal portfolio; international risk sharing; international portfolio allocation; exchange rate hedging; equity home bias; goods price; equity portfolio; Home goods; asset portfolio-equities; price flexibility; sticky-price portfolio balance model; forward rate; balance model; cash flow; Stocks; Sticky prices; Currencies; Hedging; Consumption (search for similar items in EconPapers)
Pages: 47
Date: 2009-01-01
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Citations: View citations in EconPapers (98)

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Journal Article: The International Diversification Puzzle When Goods Prices Are Sticky: It's Really about Exchange-Rate Hedging, Not Equity Portfolios (2009)
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