International equity holdings and stock returns correlations: Does diversification matter at all for portfolio choice?

Do investors completely ignore the basics of portfolio theory? Given their over-exposure on domestic risk, investors should try to hedge this risk by picking foreign assets that have low correlation with their home assets. In the data though, we find a robust positive relationship between bilateral equity holdings and bilateral return correlations. We argue that this finding could be driven by the common impact of "financial integration" on cross-border equity holdings and on cross-market correlations. Indeed, when we instrument current correlation with past correlation to control for endogeneity, we recover asset demand functions that decrease with return correlation.international portfolio choice ; international stock return correlations ; financial integration ; endogeneity bias

A Dynamic Equilibrium Model of Imperfectly Integrated Financial Markets

The goal of this paper is to analyze the determination of countries equity portfolios and countries stock returns behavior in the context of imperfectly integrated financial markets. We build a continuous-time equilibrium model of a two-country endowment economy in which the level of financial integration is simply captured by with holding taxes on foreign dividends. Despite the heterogeneity among investors induced by these taxes, we obtain approximate closed-form expressions for asset prices and we characterize equity holdings and national assets returns behavior in equilibrium. The existence of a friction akin to a with holding tax on foreign dividends has two opposite effects on portfolios: the first mechanical effect is to reduce foreign holdings by reducing expected returns on foreign assets; but there is a second effect, which is to reduce endogenously the correlation between national asset returns, thus increasing the willingness to diversify internationally. Quantitatively, we show that the direct effect dwarfs the indirect effect and we find that, for a reasonably high level of substituability between national assets, small frictions on equity markets can generate a large home bias in portfolios. Empirically, our model is consistent with a broad range of findings on international financial integration. Moreover, we provide an explanation for the puzzling positive relationship that has been found in the data between bilateral equity holdings and bilateral stock returns correlations.Asset Pricing with Heterogeneous Investors; Financial Integration; Home Bias in Portfolio; International Stock Returns Correlations; Stochastic Pareto-Negishi Weight

International Portfolio Diversification Is Better Than You Think

Do investors completely ignore the basics of portfolio theory? Given their over-exposure on domestic risk, investors should try to hedge this risk by picking foreign assets that have low correlation with their home assets. In the data though, we find a robust positive relationship between bilateral equity holdings and bilateral return correlations. We argue that this finding could be driven by the common impact of financial integration on cross-border equity holdings and on cross-market correlations. Indeed, when we instrument current correlations with past correlations to control for endogeneity, we recover asset demand functions that decrease with returns correlation.Endogeneity Bias; Financial Integration; International Portfolio Choice; International Stock Return Correlations

A dynamic equilibrium model of imperfectly integrated financial markets

We build a continous-time general equilibrium model of a two-country, pure-exchange economy featuring taxes on the repatriation of dividends. We find approximate closed-form expressions for asset prices, returns joint dynamics and equity portfolios, thus giving a full description of equilibrium in-between the polar cases of perfect integration and full segmentation. We show that large home bias in portfolios can result from small frictions on international financial markets. The reason is that, partly due to portfolio rebalancing, the international correlation of returns is very high - making assets close substitutes and implying that slight frictions have a dramatic effect on portfolio composition.asset pricing ; financial integration ; home bias in portfolio ; international stock returns correlations ; asymmetric taxation ; investors heterogeneity ; stochastic pareto-negishi weight

On clustering procedures and nonparametric mixture estimation

This paper deals with nonparametric estimation of conditional den-sities in mixture models in the case when additional covariates are available. The proposed approach consists of performing a prelim-inary clustering algorithm on the additional covariates to guess the mixture component of each observation. Conditional densities of the mixture model are then estimated using kernel density estimates ap-plied separately to each cluster. We investigate the expected L 1 -error of the resulting estimates and derive optimal rates of convergence over classical nonparametric density classes provided the clustering method is accurate. Performances of clustering algorithms are measured by the maximal misclassification error. We obtain upper bounds of this quantity for a single linkage hierarchical clustering algorithm. Lastly, applications of the proposed method to mixture models involving elec-tricity distribution data and simulated data are presented

Import price dynamics in major advanced economies and heterogeneity in exchange rate pass-through

This paper aims at showing heterogeneity in the degree of exchange rate pass-through to import prices in major advanced economies at three different levels: 1) across destination markets; 2) across types of exporters (distinguishing developed economy from emerging economy exporters); and 3) over time. Based on monthly data over the period 1991-2007, the results show first that large destination markets exhibit the lowest degree of pass-through. The degree of pass-through for goods imported from emerging economies is also significantly lower than for those from developed economies. Regarding the evolution over time, no clear change in pricing behaviours can be identified and particular events, like large exchange rates depreciations during the Asian crisis, seem to influence the degree of pass-through related to imports from emerging economies. JEL Classification: E31, F3, F41Exchange Rate Pass-Through, Import price modeling, Pricing to Market