International Portfolio Holdings andSwiss Franc Asset Returns

The innovations of this paper are fourfold: First we study return differentials more comprehensivelythan in the previous literature by comparing three asset classes : money market instruments, bonds andequities across countries. Second, we document the structure of international portfolio holdings inSwitzerland. Third, we examine the merit of one of the most commonly held believes about the natureof the puzzle: the role of foreign demand for Swiss Francs, possibly motivated by banking secrecy.Fourth, we propose a new explanation for the puzzle based on a portfolio perspective.The main findings are as follows. We find that returns are only lower for fixed income assets and notfor equity. Moreover, it is mostly due to a long run deviation from uncovered interest rate parity, not adeviation from purchasing power parity. These findings cast some doubt on two of the most widespread explanations for the interest rate island. If the puzzle was mainly due to real or structural forcessuch as high capital intensity or a productivity differential between non tradables and tradables itshould manifest through a deviation from purchasing power parity. If the puzzle could be explained bya peso problem it should apply also to equity. [