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International portfolio choice: liquidity constraints and the home equity bias puzzle

Michaelides, Alexander (2001) International portfolio choice: liquidity constraints and the home equity bias puzzle. 3066. Centre for Economic Policy Research, London, UK.

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Abstract

This Paper solves for optimal international portfolio choice in the presence of liquidity constraints and undiversifiable labour income risk. Optimal portfolios are internationally diversified while positive correlation between domestic stock market returns and permanent labour income shocks can worsen the home equity bias puzzle. Nevertheless, either small costs associated with investing abroad or a slightly positive domestic to foreign equity premium differential are sufficient to either deter households from participating in a foreign market or generate a substantial bias for home equities. The benefits of international diversification are limited because consumption fluctuations can be smoothed with a small amount of buffer stock saving, while exchange rate risk makes foreign investments less appealing to risk averse investors.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.cepr.org
Additional Information: © 2001 Alex Michaelides
Library of Congress subject classification: H Social Sciences > HG Finance
Journal of Economic Literature Classification System: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E20 - General
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Departments > Economics
Collections > LSE Financial Markets Group (FMG) Working Papers
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 3066
Date Deposited: 04 Jun 2008 16:40
URL: http://eprints.lse.ac.uk/5364/

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