(Asymmetric) Trade Costs, Real Exchange Rate Hedging, and Equity Home Bias in a Multi-Country Model

36 Pages Posted: 20 Sep 2017 Last revised: 19 Oct 2017

See all articles by Ju Hyun Pyun

Ju Hyun Pyun

Korea University Business School (KUBS)

Date Written: September 15, 2017

Abstract

There has been controversy between (two-country) theory and the empirics about whether hedging against real exchange rate fluctuations in the goods market influences foreign equity holdings. This study reconciles the theory with the empirics by introducing a multi-country framework with asymmetric trade costs. We find that the incentive to hold foreign equities to hedge real exchange rate risk is negligible because multiple trade partners act as a hedging channel for real exchange rate fluctuations. Further, our theory calls for a country’s covariance-variance ratio to be constructed as the sum of the bilateral covariance-variance ratios of the multiple partners. The empirical analysis of 24 advanced countries confirms the theoretical prediction.

Keywords: Multi-country model, International portfolio allocation, Real exchange rate hedging, Equity home bias, Trade costs, Non-tradable goods

JEL Classification: F30, F36, F41, G11

Suggested Citation

Pyun, Ju Hyun, (Asymmetric) Trade Costs, Real Exchange Rate Hedging, and Equity Home Bias in a Multi-Country Model (September 15, 2017). Available at SSRN: https://ssrn.com/abstract=3039103 or http://dx.doi.org/10.2139/ssrn.3039103

Ju Hyun Pyun (Contact Author)

Korea University Business School (KUBS) ( email )

145 Anam-Ro, Seongbuk-Gu
Seoul, 02841
Korea, Republic of (South Korea)
82-2-3290-2610 (Phone)

HOME PAGE: http://sites.google.com/site/juhyunpyun/research

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