Essays in International Portfolio Choice

The last four decades have witnessed a steady increase of foreign equity holdings share. From 1970 to 2004, the share of equities owned by foreign investors increased by five times in the United States, seven times in Japan, and fifteen times in the United Kingdom. In his 2007 Ohlin lecture, Obstfeld stated ``€œit is imperative to understand how investors make asset allocation decisions for different asset classes across countries.''€ This dissertation analyzes international portfolio choice along two dimensions.

In the first chapter, I develop a theory for bilateral asset holdings that takes a gravity form. I discuss how to estimate international financial frictions and conduct a comparative statics analysis within the context of the theory. I also find though that reasonable extensions of the model no longer generate a gravity form. While this does not significantly complicate estimation and comparative statics analysis, it raises questions about the empirical validity of gravity specifications for cross-border financial holdings that need to be addressed in future work.

The second chapter analyzes the impact of the changes in foreign asset holdings on welfare. This chapter adds within-country heterogeneity to the standard open-economy dynamic general equilibrium portfolio choice model. The solution method is illustrated with a preliminary calibration. Decrease of proportional costs is beneficial to the rich agents but harmful to the poor agents whereas decrease of fixed cost is beneficial to the poor agents and has no effect on the rich agents.