Nontraded goods, nontraded factors, and international non-diversification

Abstract

Can the presence of nontraded consumption goods or nontraded factors of production explain the high degree of “home bias” displayed by investor portfolios? We find that the answer is no, so long as individuals have access to free international trade in financial assets. In particular, it is never optimal to exhibit home bias with respect to domestic traded-good equities. By contrast, holdings of nontraded-good equities in an optimal portfolio will depend sensitively on the elasticity of substitution between traded and nontraded goods.

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