Essays on international portfolio diversification and asset prices
This dissertation consists of three essays addressing issues of the home bias in international equity investment and the puzzles in asset prices. In the first chapter, we consider a two-period, two-country general equilibrium model in which agents' portfolios are endogenously determined. We show that fixed costs, heterogeneity of wealth, and incomplete financial markets can generate the home bias. Numerical examples show that the level of the fixed costs needed for the home bias is in a plausible range. The second chapter considers two facts in stock markets. First, investors own very few stocks in their portfolios. Second, stocks are indivisible in the sense that investors have to trade stocks in multiples of a round lot. When we incorporate these facts into a two-period general equilibrium model, we obtain the results that are different from those of standard asset pricing models. In particular, the risk free rate is lower, the equilibrium stock prices are not unique, and the equity premium is given by an interval. In numerical examples, we show that with the coefficient of relative risk aversion less than 2, we can generate the levels of the risk free rate and the equity premium we observe in the data. In the third chapter, we consider the effects of the diversification by a mutual fund on asset prices in a two-period general equilibrium model in which stocks are indivisible. A numerical example shows that the equilibrium stock prices are given by an interval and the dividends cannot pin down the equilibrium stock prices. It is also shown that our model can generate plausible ranges of the rates of return on mutual fund shares and stocks with the coefficient of relative risk aversion less than 2. Although the range of the equity premium is much larger than that of the standard model, it is smaller than the data because the risk free rate is too high.
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