International Equilibrium Portfolios and Capital Flows

In this paper, we study the interaction between cross-border financial flows and asset prices. We model a two-country, two-goods, production economy where agents can trade domestic and foreign short-term bonds, long-term... [ view full abstract ]

In this paper, we study the interaction between cross-border financial flows and asset prices. We model a two-country, two-goods, production economy where agents can trade domestic and foreign short-term bonds, long-term bonds and equity, which dynamically complete the markets. We first solve for a particular parametrization of the model that allows us to solve the model in closed-form. In this case with log-linear preferences, Cobb-Douglas aggregator for the final good, and Cobb-Douglas investment, we solve for the equilibrium portfolio and find that holdings of shares of the foreign and domestic firm are undetermined. We then
study numerically how home-bias arises as we relax these assumptions. Finally, we investigate whether our model can account for the main empirical properties of financial international flows and asset prices.