One Proposition about Dynamic Portfolio Selection in an Open Economy and International Diversification

Aoki, Takaaki (2008): One Proposition about Dynamic Portfolio Selection in an Open Economy and International Diversification. Published in: Economics Bulletin , Vol. Vol. 6, (April 2008): pp. 1-8.

Abstract

This paper describes one proposition about dynamic Markowitz portfolio selection in an open economy. Here it is proved that, assuming that two countries in an open economy share the same risk absolute aversion coefficient and the same information set with some conditions, the portfolio each country holds always attains the same rate of return, regardless of the characteristics of each country’s risky asset market, of the proportion in each country’s personal asset holdings, of the characteristics of the exchange rate price process, or of the risk free rate in each country. One basic implication of this proposition is that, when two countries share the common information set, each country might be, under these non-general conditions, indifferent, regarding the allocation of home/foreign risky assets, to the diffusion of exchange rate price process. Finally, I discuss another implication of this proposition in the relation with international portfolio diversification and so called “the home bias puzzle”.

• Item Type: MPRA Paper
• Language: English
• Keywords: Dynamic portfolio selection; Open economy; Common information sharing; Home bias puzzle
• Subjects: F - International Economics > F0 - General; F - International Economics > F3 - International Finance; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty

References

Constantinides, G.M. and A.G. Malliaris (1995) “Portfolio Theory (Chapter 1)”, Handbooks in OR & MS, Vol.9 (R. Jarrow et al. Eds.), Elsvier Science

Grauer, Robert R and Nils H. Hakansson (1987) “Gains from International Diversification: 1968-1985 Returns on Portfolio of Stocks and Bonds”, Journal of Finance, Vol.42, pp.721-739, July 1987

Obstfeld, Maurice and Kenneth Rogoff (1996) “Foundation of International Macroeconomics”, The MIT Press, pp.304-306, pp.325-332

Coakely, Jerry, Ana-Maria Fuertes and Ron Smith (2006) “Unobserved Heterogeneity in Panel Time Series Models”, Computational Statistics & Data Analysis, Vol. 50, Issue 9, pp. 2361-2380, May 2006

Drine, Imed and Christophe Rault (2007) “Purchasing Power Parity for Developing and Develoed Countries: What Can We Learn From Non-Stationary Panel Data Models?”, IZA Discussion Papers #2887, Institute for the Study of Labor (IZA)

Tesar, Linda L. and Ingrid Werner (1995) “Home Bias and High Turnover”, Journal of International Money and Finance, Vol.14, pp.467-492, August 1995