European Business Schools Librarian's Group

ESSEC Working Papers,
ESSEC Research Center, ESSEC Business School

No DR 06011: Do Trade Costs in Goods Market Lead to Home Bias in Equities?

Nicolas Coeurdacier ()
Additional contact information
Nicolas Coeurdacier: ESSEC Business School, Postal: Avenue Bernard Hirsch - B.P. 50105, 95021 CERGY-PONTOISE Cedex , FRANCE,

Abstract: Two of the main puzzles in international economics are the consumption and the portfolio home biases. They are empirically related: countries that are more open to trade also have more internationally diversified portfolios. In a two-country stochastic equilibrium model, I prove that introducing trade costs in goods market alone, as suggested by Obstfeld and Rogoff [2000], is not sufficient to explain these two puzzles simultaneously. On the contrary, for reasonable parameter values, trade costs create a foreign bias in portfolios. To reconcile facts and theory, I introduce a combination of small frictions in financial markets and trade costs in goods market. The interaction between the two types of frictions determines optimal portfolio allocation. When trade costs increase, competition in the goods market softens and the volatility of domestic income falls. Facing lower risk, investors have less incentive to pay the financial transaction cost and increase their holdings of domestic assets. The model correctly predicts that the larger the home bias in consumption, the larger the home bias in portfolios.

Keywords: International Macroeconomics; Home Bias; Portfolio Choice; Trade Costs

JEL-codes: F30; F36; F41; G11

39 pages, October 2006

Full text files

showDeclFileRes.do?declId=6625&key=__workpaper__ PDF-file 

Download statistics

Questions (including download problems) about the papers in this series should be directed to Sophie Magnanou ()
Report other problems with accessing this service to Sune Karlsson ().

This page generated on 2024-02-05 15:47:16.