Econometrica: Nov, 2001, Volume 69, Issue 6

A Dynamic Equilibrium Model of International Portfolio Holdings

https://doi.org/10.1111/1468-0262.00254
p. 1467-1489

Angel Serrat

This paper develops a continuous‐time equilibrium model of a two‐country exchange economy with heterogeneous agents and nontraded goods. Nontraded goods play the role of state variables that shift the marginal utility of traded goods. This affects prices and generates dynamic hedging demands that explain the well documented home bias puzzle in international equity portfolios. When calibrated to both consumption and production data, the model is able to generate significative home bias in equity portfolios.