International portfolio choice and home bias: the effects of commodity market imperfections

Finance

IFA Working Paper

2003

We investigate the impact of commodity market restrictions, such as non-tradable goods, costs for trading goods internationally, and subsistence levels of consumption, on international portfolio choice in a general equilibrium model of a two-country economy. We find that neither finite transactions costs in the goods markets nor minimum levels of subsistence consumption can explain the observed bias in international portfolios towards domestic equities. In contrast, in the presence of non-traded goods the optimal portfolio as a whole exhibits a substantial bias towards domenstic equities, and a simple calibration exercise shows that the degree of bias exhibited by the international portfolio in the theoretical model is of similar magnitude to that observed in the data. However, at the sectoral level the pattern is not satisfactory. The combined model, with transaction costs for all goods, does not generate pervasive home bias either.

Institute of Finance and Accounting

FIN 392

IFA Working Paper

No