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Hedging Against the Government: A Solution to the Home Asset Bias Puzzle

Tiago C. Berriel and Saroj Bhattarai
American Economic Journal: Macroeconomics
Vol. 5, No. 1 (January 2013), pp. 102-134
Stable URL: http://www.jstor.org/stable/43189932
Page Count: 33
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Hedging Against the Government: A Solution to the Home Asset Bias Puzzle
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Abstract

We explain why international nominal bonds and equity portfolios are biased domestically. In our model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: nominal risk and taxes only on domestic agents. A third feature explains domestically biased equity holdings: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. A calibrated version of the model predicts asset holdings that quantitatively match the data.

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