Country portfolios under global imbalances

Abstract

This paper studies the composition of country portfolios under global imbalances. When countries are identical, the optimal portfolio is fully diversified, which reflects the cross-country symmetric self-hedging (Lucas, 1982). Assuming a structural country asymmetry in patience, we construct a model of portfolio choices that features persistent non-zero net foreign assets (NFA). Because the latter opens a gap between GNP and GDP, we found that an asymmetric hedging of net portfolio returns emerges in addition to the otherwise only Lucas’ symmetric self-hedging in shaping the gross country portfolios, which implies a short (long) position of the local asset in the debtor (creditor) country. The resulting portfolio is home biased. We calibrate our model to the U.S. and China data over 1999–2017 and show that it matches the portfolio data for countries with unbalanced net external positions well.