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International Risk Sharing: Through Equity Diversification or Exchange Rate Hedging?

Author/Editor: Engel, Charles | Matsumoto, Akito
Authorized for Distribution: July 1, 2009
Electronic Access: Free Full Text (PDF file size is 759KB)
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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: Well-known empirical puzzles in international macroeconomics concern the large divergence of equilibrium outcomes for consumption across countries from the predictions of models with full risk sharing. It is commonly believed that these risk-sharing puzzles are related to another empirical puzzle-the home-bias in equity puzzle. However, we show in a series of dynamic models that the full risk sharing equilibrium may not require much diversification of equity portfolios when there is price stickiness of the degree typically calibrated in macroeconomic models. This conclusion holds under a range of assumptions about home bias in preferences, price setting as PCP or LCP, and with or without nominal wage stickiness as long as there is some price rigidity.
 
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Series: Working Paper No. 09/138
Subject(s): Asset prices | Bonds | Consumer goods | Domestic investment | Economic models | Exchange rates | Financial risk | Flexible pricing policy | Foreign exchange | Hedge funds | Price elasticity | Prices | Private investment | Stock prices
Author's keyword(s): International portfolio choice | international risk sharing | international diversification
 
English  
    Published:   July 1, 2009        
            Format:   Paper
    Stock No:   WPIEA2009138   Pages:   45
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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