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

January 1, 2009

Preview Citation

Format: Chicago

Akito Matsumoto, and Charles Engel. The International Diversification Puzzle when Goods Prices Are Sticky: It's Really About Exchange-Rate Hedging, not Equity Portfolios, (USA: International Monetary Fund, 2009) accessed November 21, 2024

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.

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

Keywords: Asset portfolio-equities, Balance model, Cash flow, Consumption, Currencies, Equity home bias, Equity portfolio, Exchange rate, Exchange rate hedging, Forward rate, Goods price, Hedging, Home goods, International portfolio allocation, International risk sharing, Optimal portfolio, Price flexibility, Sticky prices, Sticky-price portfolio balance model, Stocks, WP

Publication Details

Pages:

47
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2009/012
Stock No:

WPIEA2009012
ISBN:

9781451871593
ISSN:

1018-5941

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