We show that international home bias in debt and equity holdings has declined during the late 1990s at the same time as international risk sharing has increased. Using panel data estimations, we demonstrate that less home bias is associated with more international risk sharing. Alternatively, we show that the higher the level of foreign assets to Gross Domestic Product, the more risk sharing is obtained. This indicates that lack of risk sharing and international financial integration are closely related empirical phenomena. JEL Classification: F36

Why do investors trade a lot in foreign assets and hold so little of them in their portfolios? This paper shows that both observations can arise naturally in the presence of nondiversifiable nontraded consumption risk when each country specializes in production, preferences exhibit consumption home bias, and asset markets are incomplete. Using a general equilibrium two-country, two-sector (tradable and nontradable) model of the world economy with production I show that low diversification occurs because variations in relative prices (i) increase the riskiness of foreign assets and (ii) facilitate risk-sharing across countries. Large and volatile capital flows are necessary to take advantage of international risk premia differentials that occur in response to productivity changes in the nontradable sector. I characterize the optimal portfolio holdings, the evolution of the investment opportunity set, the risk premium, and the dynamics of capital flows using a new methodology for solving dynamic general equilibrium models with incomplete markets and portfolio choice. JEL Classification: C68; D52; G11.

Despite the liberalization of capital ‡ows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversi…cation, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversi…ed portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation, shocks to the e ¢ ciency of physical investment, as well as international trade in stocks and bonds. In our model, domestic stocks are used to hedge ‡uctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversi…cation does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital ‡ows. JEL classi…cation: F2, F3, G1.

This paper reviews the recent literature on equity home bias – the empirical finding that people overinvest in domestic stocks relative to the theoretically optimal investment portfolio. We cover different home bias measures and we illustrate the extent and the evolution of equity home bias both with recent portfolio holdings data and longer time series. Institutional-based and behavior-based explanations for the puzzle are considered and discussed. We conclude that none of the proposed theories can explain the full extent of the bias by itself, thus we argue that international portfolio choice should be explained by a mixture of rational and irrational behavior. ∗Rosanne Vanpée, the corresponding author

This paper brings together the literature on determination of home bias in equity holdings and the portfolio balance model of exchange rates to consider whether the dollar might be affected by a change in transactions costs that alters international portfolio allocations. Our empirical findings lend support to the view that transactions costs have a significant influence on US portfolio holdings, even after accounting for float market share. In addition, new survey evidence on the equity holdings of European firms indicates home bias for European investors, and points to a reduction in the magnitude of this home bias since 1997. This paper was produced as part of the International Financial Stability Programme at the

2006 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Partly reflecting structural advantages such a liquidity and strong investor protection, foreigners have built up extremely large positions in U.S. (as well as other dollar-denominated) financial assets. This paper describes the impact on global wealth of an unanticipated shock to U.S. financial markets. For every 10 percent decline in the dollar, U.S. equity markets, and U.S. bond markets, total wealth losses to foreigners could amount to about 5 percentage points of foreign GDP. Four stylized facts emerge: (i) foreign countries, particularly emerging markets, are more exposed to U.S. bonds than U.S. equities; (ii) U.S. exposure has increased for most countries; (iii) on average, U.S. asset holdings of developed countries and emerging markets (scaled by GDP) are very similar; and (iv) based on their

The Centre for Market and Public Organisation (CMPO) is a leading research centre, combining expertise in economics, geography and law. Our objective is to study the intersection between the public and private sectors of the economy, and in particular to understand the right way to organise and deliver public services. The Centre aims to develop research, contribute to the public debate and inform policymaking. CMPO, now an ESRC Research Centre was established in 1998 with two large grants from The Leverhulme Trust. In 2004 we were awarded ESRC Research Centre status, and CMPO now combines core funding from both the ESRC and the Trust. Centre for Market and Public Organisation

This paper brings together the literature on determination of home bias in equity holdings and the portfolio balance model of exchange rates to consider whether the dollar might be affected by a change in transactions costs that alters international portfolio allocations. Our empirical findings lend support to the view that transactions costs have a significant influence on US portfolio holdings, even after accounting for float market share. In addition, new survey evidence on the equity holdings of European firms indicates home bias for European

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper proposes a new definition of Offshore Financial Centers (OFCs) and develops a statistical method to differentiate between OFCs and non-OFCs using data from the Coordinated Portfolio Investment Survey (CPIS), the International Investment Position (IIP), and the balance of payments. The suggested methodology identifies more than 80 percent of the OFCs in the study sample that also appear in the a priori list used by the IMF to conduct its OFC assessment program. The methodology distinguishes OFCs based strictly on their macroeconomic features and avoids subjective presumptions on their activities or regulatory frameworks. The study also identifies three new countries meeting OFC criteria.

What drives portfolio investments of German banks in emerging capital markets?