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Federal Reserve Bank of Dallas
Globalization Institute Working Papers
Hedging against the government: a solution to the home asset bias puzzle
Tiago C. Berriel
Saroj Bhattarai
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.


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Tiago C. Berriel & Saroj Bhattarai, Hedging against the government: a solution to the home asset bias puzzle, Federal Reserve Bank of Dallas, Globalization Institute Working Papers 113, 2012.
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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.
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