Research Papers
Portfolio Choice Analysis in a Multi-country Macro Model December 2023
This paper examines portfolio choice in a DSGE model with frictional trade and financial linkages across 43 countries. I conduct comparative statics analysis with this structural model to quantify potential mechanisms of global financial allocation, including risk hedging, risk diversification, risk sharing, and financial friction. For asset home bias, the model predicts that risk hedging is less essential in a multi-country than in a two-country setting. For bilateral asset positions, the model implies that variations in financial friction and asset covariance are major determinants of countries' observed portfolios. Meanwhile, bilateral financial linkages strongly covary with trade linkages across countries. Counterfactual analysis suggests that the covariance is mainly driven by the high correlation of frictions across the two channels of globalization.
This paper examines portfolio choice in a DSGE model with frictional trade and financial linkages across 43 countries. I conduct comparative statics analysis with this structural model to quantify potential mechanisms of global financial allocation, including risk hedging, risk diversification, risk sharing, and financial friction. For asset home bias, the model predicts that risk hedging is less essential in a multi-country than in a two-country setting. For bilateral asset positions, the model implies that variations in financial friction and asset covariance are major determinants of countries' observed portfolios. Meanwhile, bilateral financial linkages strongly covary with trade linkages across countries. Counterfactual analysis suggests that the covariance is mainly driven by the high correlation of frictions across the two channels of globalization.
General Equilibrium Analysis of Multinational Financial and Trade Linkages [slides] December 2023
This paper develops a quantitative framework where trade and financial linkages are jointly characterized in a multi-country setting. The model captures the potential interaction of finance and trade in general equilibrium: financial allocations reflect agents' risk-sharing patterns influenced by the global trade structure, and countries' asset positions shift demand in the world goods market. The model is solved with a novel approach that combines the linearization method for portfolio choice analysis in a DSGE framework and the exact hat algebra technique from the trade literature. Comparative statics analyses employing the approach elucidate the welfare impacts of tariffs and financial frictions as obstacles to globalization.
This paper develops a quantitative framework where trade and financial linkages are jointly characterized in a multi-country setting. The model captures the potential interaction of finance and trade in general equilibrium: financial allocations reflect agents' risk-sharing patterns influenced by the global trade structure, and countries' asset positions shift demand in the world goods market. The model is solved with a novel approach that combines the linearization method for portfolio choice analysis in a DSGE framework and the exact hat algebra technique from the trade literature. Comparative statics analyses employing the approach elucidate the welfare impacts of tariffs and financial frictions as obstacles to globalization.
What Explains Equity Home Bias? Theory and Evidence at the Sector Level [slides] (November 2023, EER, Volume 160)
This paper examines the well-known home bias puzzle in international finance by exploiting the cross-sector variation. Using unique financial datasets, I calculate a sectoral home bias index that covers 27 industries in 43 countries, which enables empirical and theoretical analysis of the puzzle in unprecedented detail. The major empirical patterns include (1) sectoral home bias is stronger for nontradable sectors and in countries with a higher degree of capital restrictions, and (2) investors tilt portfolios more towards domestic assets for the sectors in which their countries reveal a comparative advantage. Motivated by these findings, I build a multi-sector model that incorporates transaction costs, information asymmetry, and risk-hedging motives in investors' portfolio choice. Moreover, I quantify the effects of these frictions on both sector- and country-level home bias in a calibrated DSGE model.
Spatial Consumption Risk Sharing [slides] (with P Arora and D Choo) April 2023, under revision
This paper examines how bilateral economic linkages shape consumption synchronization across economies. Using state-level data from the US, we find that the degree of bilateral consumption risk sharing decreases with geographic distance. To explain this novel fact, we develop an open economy DSGE model that incorporates trade, migration, and finance as channels of risk sharing which are subject to frictions that covary with distance. Calibrated to the US data, the model not only enables us to quantify the magnitude of the frictions in each channel, but also allows us to examine the interaction of the channels and disentangle their effects on the level, volatility, and comovement of consumption. Counterfactual analyses based on the model provide guidance for the design of macroeconomic policies that aim to reduce consumption disparity.
This paper examines how bilateral economic linkages shape consumption synchronization across economies. Using state-level data from the US, we find that the degree of bilateral consumption risk sharing decreases with geographic distance. To explain this novel fact, we develop an open economy DSGE model that incorporates trade, migration, and finance as channels of risk sharing which are subject to frictions that covary with distance. Calibrated to the US data, the model not only enables us to quantify the magnitude of the frictions in each channel, but also allows us to examine the interaction of the channels and disentangle their effects on the level, volatility, and comovement of consumption. Counterfactual analyses based on the model provide guidance for the design of macroeconomic policies that aim to reduce consumption disparity.
Industrial Specialization Matters: A New Angle on Equity Home Bias (Sep 2020, JIE, Volume 126)
This paper theoretically and empirically examines how industrial structure affects international portfolio diversification. I embed portfolio choice analysis in a multi-sector Eaton-Kortum model in order to explore how sectoral productivity differences affect a country's risk exposure and hence influence its equity home bias. The model predicts that investors from highly specialized economies who want to hedge their risk have a strong incentive to avoid domestic assets. I confirm the prediction with the data by finding that home bias is negatively correlated with a country's degree of industrial specialization. This finding unveils the interaction between intranational risk hedging across sectors and international risk hedging across countries.
Data File
This paper theoretically and empirically examines how industrial structure affects international portfolio diversification. I embed portfolio choice analysis in a multi-sector Eaton-Kortum model in order to explore how sectoral productivity differences affect a country's risk exposure and hence influence its equity home bias. The model predicts that investors from highly specialized economies who want to hedge their risk have a strong incentive to avoid domestic assets. I confirm the prediction with the data by finding that home bias is negatively correlated with a country's degree of industrial specialization. This finding unveils the interaction between intranational risk hedging across sectors and international risk hedging across countries.
Data File
Trade Costs and A Gravity Model of Risk Sharing (with F Chertman and D Choo) July 2020
This paper presents new evidence that trade costs impede cross-country consumption risk sharing. Our analysis exploits cross-sectional and time-series variations in trade costs across country pairs. Using the data for a large panel of countries over the period 1970-2014, we find that bilateral risk sharing improves once a pair of countries become partners under a regional trade agreement. Moreover, we establish a gravity model of consumption risk sharing by finding that countries that are more geographically distant from each other exhibit weaker bilateral risk sharing. The effect is more pronounced in the absence of RTAs, which suggests that trade-promoting policies mitigate the impact of geographic distance on risk sharing. Furthermore, we build a causal relationship between trade and risk sharing by using instrumental variables. These empirical results point to the importance of the trade channel for international consumption risk sharing. Based on these findings, lifting trade barriers will benefit countries by reducing consumption fluctuations.
This paper presents new evidence that trade costs impede cross-country consumption risk sharing. Our analysis exploits cross-sectional and time-series variations in trade costs across country pairs. Using the data for a large panel of countries over the period 1970-2014, we find that bilateral risk sharing improves once a pair of countries become partners under a regional trade agreement. Moreover, we establish a gravity model of consumption risk sharing by finding that countries that are more geographically distant from each other exhibit weaker bilateral risk sharing. The effect is more pronounced in the absence of RTAs, which suggests that trade-promoting policies mitigate the impact of geographic distance on risk sharing. Furthermore, we build a causal relationship between trade and risk sharing by using instrumental variables. These empirical results point to the importance of the trade channel for international consumption risk sharing. Based on these findings, lifting trade barriers will benefit countries by reducing consumption fluctuations.
Optimal Trade Costs after Sovereign Defaults (with Fudong Zhang)
This paper offers new theoretical and empirical insights into the effect of sovereign defaults on trade. Empirical evidence from the changes in trade shares after debt renegotiations as well as Aid-for-trade statistics indicates that sovereign debt renegotiation is not associated with trade sanctions but with trade incentives offered by creditor countries to debtor countries. Using a two-country DSGE model with incomplete financial markets, we are able to explain why trade sanctions are not observed. Our model departs from the existing literature on sovereign defaults by building on the strategic interaction between debtors and creditors. We reason that creditors lower trade costs with debtors in hopes of collecting the remaining debt during debt renegotiations. The adjustment in turn affects debtors' default decisions. We solve the model numerically to determine the optimal trade costs given different combinations of debt and income levels.
This paper offers new theoretical and empirical insights into the effect of sovereign defaults on trade. Empirical evidence from the changes in trade shares after debt renegotiations as well as Aid-for-trade statistics indicates that sovereign debt renegotiation is not associated with trade sanctions but with trade incentives offered by creditor countries to debtor countries. Using a two-country DSGE model with incomplete financial markets, we are able to explain why trade sanctions are not observed. Our model departs from the existing literature on sovereign defaults by building on the strategic interaction between debtors and creditors. We reason that creditors lower trade costs with debtors in hopes of collecting the remaining debt during debt renegotiations. The adjustment in turn affects debtors' default decisions. We solve the model numerically to determine the optimal trade costs given different combinations of debt and income levels.
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