One Proposition about Dynamic Portfolio Selection in an Open Economy and International Diversification

This paper describes one proposition about dynamic Markowitz portfolio selection in an open economy. Here it is proved that, assuming that two countries in an open economy share the same risk absolute aversion coefficient and the same information set with some conditions, the portfolio each country holds always attains the same rate of return, regardless of the characteristics of each country’s risky asset market, of the proportion in each country’s personal asset holdings, of the characteristics of the exchange rate price process, or of the risk free rate in each country. One basic implication of this proposition is that, when two countries share the common information set, each country might be, under these non-general conditions, indifferent, regarding the allocation of home/foreign risky assets, to the diffusion of exchange rate price process. Finally, I discuss another implication of this proposition in the relation with international portfolio diversification and so called “the home bias puzzle”.