The International Diversification Puzzle when Goods Prices Are Sticky: It's Really About Exchange-Rate Hedging, not Equity Portfolios

Author/Editor:

Akito Matsumoto ; Charles Engel

Publication Date:

January 1, 2009

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper develops a two-country monetary DSGE model in which households choose a portfolio of home and foreign equities, and a forward position in foreign exchange. Some nominal goods prices are sticky. Trade in these assets achieves the same allocations as trade in a complete set of nominal state-contingent claims in our linearized model. When there is a high degree of price stickiness, we show that not much equity diversification is required to replicate the complete-markets equilibrium when agents are able to hedge foreign exchange risk sufficiently. Moreover, temporarily sticky nominal goods prices can have large effects on equity portfolios even when dividend processes are very persistent.

Series:

Working Paper No. 2009/012

Subject:

Consumption Currencies Financial institutions Financial regulation and supervision Hedging Money National accounts Prices Sticky prices Stocks

English

Publication Date:

January 1, 2009

ISBN/ISSN:

9781451871593/1018-5941

Stock No:

WPIEA2009012

Pages:

47

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