Goods Trade and International Equity Portfolios
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NBER Working Paper No. 13612
Issued in November 2007
NBER Program(s): IFM ITI
We show that international trade in goods is the main determinant of international equity portfolios and offers a compelling -- theoretically and empirically -- resolution of the portfolio home bias puzzle. The model implies that investors can achieve full international risk diversification if the share of wealth invested in foreign equity matches their country's degree of openness (the imports to GDP share). The empirical evidence strongly supports this implication.
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