Portfolio Home Bias and External Habit Formation
57 Pages Posted: 17 Dec 2011 Last revised: 2 Mar 2021
Date Written: March 1, 2021
Abstract
This paper proposes a general equilibrium model which features endogenous cross-country heterogeneity in conditional risk aversion and shows that it can generate significant equity home bias. With complete markets, financing home consumption entails hedging against increases in home conditional risk aversion. When agents trade endowment claims, an increase in home risk aversion leads to a relative appreciation of the home claim due to an endogenous demand shock which raises the price of the home good, so home risk aversion shocks are hedged by home claim holdings. When agents trade dividend claims and the dividend share of income is sufficiently procyclical, home risk aversion shocks are hedged by agents' non-traded wealth and agents hold home-biased equity portfolios that are positively exposed to increases in home risk aversion.
Keywords: Portfolio home bias, habit formation, asset pricing
JEL Classification: G11, G12, G15, F30
Suggested Citation: Suggested Citation
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