By Tiago C. Berriel and Saroj Bhattarai
This paper explains two puzzling facts: international nominal bonds and equity portfolios are biased domestically. In our two-country 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: some nominal risk and taxes falling only on domestic agents. A third feature explains why agents choose to hold primarily domestic equity: 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. These conclusions are robust to a wide range of preference parameter values and the incompleteness of financial markets. A calibrated version of the model predicts asset holdings that quantitatively match the data.
An interesting take of the portfolio home bias: it is the result of hedging against fiscal policy. But given that government expenses are procyclical in some countries and countercyclical in others, I wonder whether this can really be generalized beyond the United States, which the model economy is calibrated for.