Hedging against the government: a solution to the home asset bias puzzle
Abstract: This paper explains two puzzling facts: international nominal bonds and equity portfolios are biased domestically. In our two-country model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: some nominal risk and taxes falling only on domestic agents. A third feature explains why agents choose to hold primarily domestic equity: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. These conclusions are robust to a wide range of preference parameter values and the incompleteness of financial markets. A calibrated version of the model predicts asset holdings that quantitatively match the data.
File(s): File format is application/pdf http://www.dallasfed.org/assets/documents/institute/wpapers/2012/0113.pdf
Provider: Federal Reserve Bank of Dallas
Part of Series: Globalization Institute Working Papers
Publication Date: 2012
Pages: 62 pages
Note: Published as: Berriel, Tiago C. and Saroj Bhattarai (2013), "Hedging Against the Government: A Solution to the Home Asset Bias Puzzle," American Economic Journal: Macroeconomics 5 (1): 102-134.