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Portfolio Home Bias and External Habit Formation

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  • Andreas Stathopoulos

    (University of Southern California)

Abstract

This paper explores international portfolio choice in a multi-country, multi-good general equilibrium setting which features time-varying risk aversion generated by external habit formation. It is shown that time variation in conditional risk aversion generates time variation in the countries' relative consumption expenditure. As a result, financing equilibrium consumption entails hedging against adverse fluctuations in risk aversion. In equilibrium, an increase in home risk aversion tends to appreciate the home equity and depreciate the foreign equity, so each agent hedges by shifting her equity portfolio towards the home equity claim. Furthermore, the model is able to generate realistic asset price and exchange rate dynamics, satisfying a long-standing need of the general equilibrium literature in international finance.

Suggested Citation

  • Andreas Stathopoulos, 2012. "Portfolio Home Bias and External Habit Formation," 2012 Meeting Papers 502, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:502
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    References listed on IDEAS

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    Cited by:

    1. Hassan, Tarek A. & Mertens, Thomas M. & Zhang, Tony, 2016. "Not so disconnected: Exchange rates and the capital stock," Journal of International Economics, Elsevier, vol. 99(S1), pages 43-57.

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