Asset Prices, Global Portfolios, and the International Financial System

Abstract

I adapt the framework of Sauzet (2021) to an international setting to characterize the global solution to the international portfolio problem in full generality, a long-standing open issue in international finance. In this two-country, two-good environment, investors have recursive preferences and a bias in consumption towards their local good. The framework highlights the role of the allocation of wealth across international investors for portfolios, asset prices, and risk sharing, an aspect that had received little emphasis in such a setting. The model allows to revisit various results in the international portfolio choice literature. In addition, I show that it can replicate a number of facts about the structure and dynamics of the international financial system, and of asset returns in that context.