Goods Trade and International Equity Portfolios

Abstract

We show that international trade in goods is the main determinant of international equity portfolios and it also offers a compelling - theoretically and empirically - resolution of the portfolio home bias puzzle. The model implies that investors can achieve full international risk diversification if the share of wealth invested in foreign equity matches their country's degree of openness (the imports to GDP share). The empirical evidence strongly supports this implication.Portfolio home bias, imports, non-traded goods