By using data from all available waves of the IMF Coordinated Portfolio Investment Surveys, we explore the dynamics of the determinants of bilateral portfolio investments. The main aim of our analysis, however, is to understand whether a diversification motive can also be found, among the various determinants. We find strong evidence that, indeed, the correlation between the idiosyncratic components of GDP growth, as well as the correlation between stock returns among pair of countries, that we consider as proxies for diversification, are relevant to explain bilateral portfolio holdings, when unobserved heterogeneity is properly taken into account, by means of a fixed effect, panel estimation (where the fixed effects refer to pair of countries, rather than countries in isolation). Interestingly, the same results cannot be obtained from cross section estimations. It also turns out that the diversification motive is less relevant, if at all, in choosing whether or not to invest in a particular area.
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