Relative Factor Endowments and International Portfolio Choice

36 Pages Posted: 17 Jun 2008

See all articles by Alejandro Cunat

Alejandro Cunat

London School of Economics & Political Science (LSE) - Department of Economics; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research; Centre for Economic Policy Research (CEPR)

Christian Fons-Rosen

University of California, Merced

Date Written: June 2008

Abstract

This paper presents a model of international portfolio choice based on the pattern of comparative advantage in goods trade. Countries have varying degrees of similarity in their factor endowment ratios, and are subject to aggregate productivity shocks. Risk averse consumers can insure against these shocks by investing their wealth at home and abroad. The change in relative prices after a positive shock in a particular country provides insurance to countries that have dissimilar factor endowment ratios, but is bad news for countries with similar factor endowment ratios, since their incomes will worsen. Therefore countries with similar comparative advantages have a stronger incentive to invest in one another for insurance purposes than countries with dissimilar comparative advantages. Empirical evidence linking bilateral international investment positions to a proxy for relative factor endowments supports our theory: the similarity of host and source countries in their relative capital-labor ratios has a positive effect on the source country's investment position in the host country. The effect of similarity is enhanced by the size of host countries as predicted by the theory.

Keywords: Factor endowments, gravity equation, International portfolio choice

JEL Classification: F21, F34, G11

Suggested Citation

Cunat, Alejandro and Fons-Rosen, Christian, Relative Factor Endowments and International Portfolio Choice (June 2008). CEPR Discussion Paper No. DP6870, Available at SSRN: https://ssrn.com/abstract=1146833

Alejandro Cunat (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 20 7955 6961 (Phone)

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Christian Fons-Rosen

University of California, Merced ( email )

P.O. Box 2039
Merced, CA 95344
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
3
Abstract Views
656
PlumX Metrics