International Capital Markets with Time-Varying Preferences
69 Pages Posted: 4 Aug 2017
Date Written: August 2, 2017
We propose a 2-country asset-pricing model where agents' preferences change endogenously as a function of the popularity of internationally traded goods. We determine the effect of the time-variation of preferences on equity markets, consumption and portfolio choices. When agents are more sensitive to the popularity of domestic consumption goods, the local stock market reacts more strongly to the preferences of local agents than to the preferences of foreign agents. Therefore, home bias arises because home-country stock represents a better investment opportunity for hedging against future fluctuations in preferences. We test our model and find that preference evolution is a plausible driver of key macroeconomic variables and stock returns.
Keywords: Asset pricing, general equilibrium, heterogeneous agents, interdependent preferences, portfolio choice
JEL Classification: D51, D52, D53, E20, E21, F21, G11, G12
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