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The International Diversification Puzzle Is Not As Bad As You Think

Jonathan Heathcote () and Fabrizio Perri ()

No 13483, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In simple one-good international macro models, the presence of non-diversifiable labor income risk means that country portfoliosshould be heavily biased toward foreign assets. The fact that theopposite pattern of diversification is observed empirically constitutes the international diversification puzzle. We embed aportfolio choice decision in a frictionless two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, we derive a closed-form expression for equilibrium country portfolios. These are biased towards domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic stocks a good hedge against non-diversifiable labor income risk. We then use our our theory to link openness to trade to the level of diversification, and find that it offers a quantitatively compelling account for the patterns of international diversification observed across developed economies in recent years.

JEL-codes: F36 F41 (search for similar items in EconPapers)
Date: 2007-10
Note: EFG IFM
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Published as Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108 - 1159.

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Journal Article: The International Diversification Puzzle Is Not as Bad as You Think (2013) Downloads
Working Paper: The international diversification puzzle is not as bad as you think (2013) Downloads
Working Paper: The International Diversification Puzzle is Not as Bad as You Think (2008) Downloads
Working Paper: The international diversification puzzle is not as bad as you think (2007) Downloads
Working Paper: The International Diversification Puzzle Is Not as Bad as You Think (2007) Downloads
Working Paper: The international diversification puzzle is not as bad as you think (2004)
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