When Bonds Matter: Home Bias in Goods and Assets

Nicolas Coeurdacier (1, 2) , Pierre-Olivier Gourinchas (3)

1 ECON - Département d'économie (Sciences Po)
2 CEPR - Center for Economic Policy Research
3 UC Berkeley - University of California [Berkeley]

This paper presents a model of international portfolios with real exchange rate and non financial risks that accounts for observed levels of equity home bias. A key feature is that investors can trade domestic and foreign bonds in addition to equities. Bonds matter: in equilibrium, investors structure their bond portfolio to hedge real exchange rate risks and equity home bias arises when non-financial income risk is negatively correlated with equity returns, after controlling for bond returns. Our framework allows us to derive equilibrium bond and equity portfolios in terms of sufficient statistics - directly measurable hedge ratios. We estimate equity and bond portfolios implied by the model for G-7 countries an find strong empirical support for the theory. We are able to account for a significant share of the equity home bias and obtain a currency exposure of bond portfolios comparable to the data.

Keywords: International risk sharing; International portfolios; Equity home bias

Domains: Economics and Finance

Nicolas Coeurdacier, Pierre-Olivier Gourinchas. When Bonds Matter: Home Bias in Goods and Assets. 2015. ⟨hal-03470191⟩