Can Nontradables Generate Substantial Home Bias?

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Abstract
The past decade has witnessed an increase in the fraction of equity portfolios invested abroad, as barriers to international asset trade have significantly declined. What are the long-run implications of this process? In this paper we investigate to what extent nontradables (consumption and leisure) can affect the portfolio allocation decision in otherwise integrated capital markets. We find that hedging against nontradables shocks can account for only a small portfolio bias toward domestic assets. These results suggest that in the near future we can expect to observe sizable additional international diversification.

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