The International Diversification Puzzle is Worse Than You Think / Marianne Baxter, Urban J. Jermann.

Format:

Book

Author/Creator:

Baxter, Marianne.

Contributor:

National Bureau of Economic Research.

Jermann, Urban J.

Series:

Working Paper Series (National Bureau of Economic Research) no. w5019.

NBER working paper series no. w5019

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1995.

Summary:

Although international financial markets are highly integrated across the more well-developed countries, investors nevertheless hold portfolios that consist nearly exclusively of domestic assets. This violation of the predictions of standard theories of portfolio choice is known as the 'international diversification puzzle.' In this paper, we show that the presence of nontraded risk associated with variations in the return to human capital has dramatic implications for the optimal fraction of domestic assets in an individual's portfolio. Our analysis suggests that the returns to human capital are highly correlated with the returns to domestic financial assets. Hedging the risk associated with nontraded human capital involves a short position in national equities in an amount approximately 1.5 times the value of the national stock market. Thus optimal and value- weighted portfolios very likely involve a short position in domestic marketable assets.

Notes:

Print version record

February 1995.