A research statement, last edited Nov 2nd 2019.
JMP, last edited on Feb 19th, 2020.

Dissertations: Three Essays on International Diversification Portfolio

Dissertation committee members
Dr. Moritz Ritter (co-chair)
Dr. Charles Swanson (co-chair)
Dr. Pedro Silos

1. “International Diversification Portfolio in an Open Market Economy: The Role of Endogenous Nominal Exchange Rate.” (job market paper)

Abstract: This paper studies the international diversification portfolio choice of equity and bonds in an open market economy when endogenizing both the currency values and the nominal exchange rates, aiming at understanding whether endogenous monetary dynamics can account for the home bias puzzle of equity and bonds. With endogenous monetary variables, a portfolio-decision model is able to capture the risk sharing feature of equity and bonds by including: (1) the correlation between bonds real return and macroeconomic states, (2) the correlation between bonds real return and marginal utility of consumption, and (3) the correlation between portfolio and international price movements. To model more realistic endogenous monetary dynamics, this paper introduces the non-tradable production sector, and invents a government final-period currency purchase device that gives currency value, relates its value to economic conditions, and captures the neutrality of currency. By use of the log-linear approximation technique and a quantitative analysis under reasonable parameter values, this paper concludes that (1) endogenous monetary dynamics provide an explanation for the observed home bias of equity and bonds; (2) the degree of home bias for equity issued by local firms should be different from that for equity issued by international firms.

2. “International Diversification Portfolio in Noisy Rational Expectation Equilibria: The Role of Asymmetric Information.”

Abstract: This paper studies the linear equilibrium relation of asset prices and information, which builds on the work of Vives (2008) and others, and investigates asset trading incorporating information factors in both static and dynamic trading versions of a noisy rational expectation equilibrium model. The paper discovers that rational traders trade assets for two separate purposes. (1) Speculation: rational traders speculate based on asset price fluctuations, which is public information. (2) Investment: rational traders follow private information about the asset true value for investment decisions, therefore the price elasticity of a trader’s investment is positively associated with that trader’s private signal precision. When traders have asymmetric information, the private information is more precise for the domestic asset over the foreign asset, rational traders rely more heavily on the private information with higher precision and invest more aggressively in domestic assets than foreign assets in both static and dynamic trading. This paper also finds asymmetric information has a lasting impact on later trading behaviors, causing rational traders be more sensitive to price changes of the asset which they have more precise information on.

3. “Diversification Benefits of Foreign Currency Denominated Assets.”

Abstract: This paper examines how international investing options would have altered the lifetime utility of a representative U.S. investor with consumption. By applying the argument of Lucas (2003) and elsewhere, this paper quantitatively analyzes the potential utility gain from adding a set of equity and bonds denominated by foreign currencies to the portfolio choices of investors. Mean-variance spanning tests are conducted as well.

4. “International Diversification Portfolio in an Open Market Economy: The Role of International Trade Cost.”

Abstract: This paper addresses the questions of whether international trade costs in goods market can explain the observed home bias of equity and corporate bonds. Under reasonable parameter values, my result supports the theory of Obstfeld & Rogoff (2000) that home bias of assets can be a consequence of goods market frictions. Moreover, this paper concludes that domestic bonds provide a stronger hedge against domestic nominal shocks compared to domestic equity, which offers a theoretical answer to the empirical observation that the degree of home bias in corporate bonds is greater than that in equity for most of the OECD countries.

5. “International Diversification Portfolio and the Backus-Smith Puzzle: The Role of Endogenous Nominal Exchange Rate.” (in progress)

Abstract: This paper explores whether the international portfolio under endogenous monetary dynamics can account for the real exchange rate volatility and risk sharing puzzles. Nominal exchange rates, income distribution, and trade flows are the three major channels of how real exchange rate dynamics can be influenced by international portfolio.

JEL codes:
E4: Macroeconomics and Monetary Economics: Money and Interest Rates
F3: International Economics: International Finance
F4: International Economics: Macroeconomic Aspects of International Trade and Finance
G1: Financial Economics: General Financial Markets