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CEP discussion paper
Portfolio Allocation and International Risk Sharing
Gianluca Benigno and Hande Küçük-Tuger
April 2011
Paper No' CEPDP1048:
Full Paper (pdf)

JEL Classification: F31; F41

Tags: portfolio choice; incomplete financial markets; international risk sharing; consumption-real exchange rate anomaly

Recent contributions have shown that it is possible to account for the so-called consumption-real exchange anomaly in models with goods market frictions where international asset trade is limited to a riskless bond. In this paper, we consider a more realistic international asset market structure and show that as soon as we depart from the single bond economy, we can no longer account for the consumption-real exchange anomaly. Our central result holds for a simple asset market structure in which two nominal bonds are traded across countries. We explore the role of demand shocks such as news shocks in generating meaningful market incompleteness. We show that only under specific settings news shocks can improve the performance of the model in matching the portfolio positions and consumption-real exchange rate correlations that we observe in the data.