Asset home bias in debtor and creditor countries

Emerging and developing countries have a less diversified international portfolio than developed countries (Coeurdacier and Rey, 2013). This paper explores the hypothesis that this actually reflects a stronger preference of a creditor country for the local asset than of a debtor country. We first document a significantly positive relation between a country’s NFA and its degree of portfolio home bias, and then develop an asymmetric two-country model to show that: (1) when net external positions are unbalanced, countries have an incentive to hedge against the risk associated with international interest payments; (2) depending on their status on external payments, the hedging works the opposite way in the two countries; and (3) taking the local asset as an example, the hedging is positive in the creditor country while negative in the debtor country so the creditor country will demand more local asset than the debtor country.