Analyzing international portfolio strategy with home event risk versus foreign information asymmetry
- The basic model
- The optimal portfolio choice
- Numerical results
This study develops a model for international portfolio choice in the presence of the home asset with event-risk versus foreign asset with stochastic information filtering. The model is constructed from comparing the portfolio fraction changes of domestic assets so as to maximize the expected utility of his terminal wealth by the relative standard deviation on both foreign and home asset returns. We provide a more accurate analysis on international portfolio choice when the home asset suffers a tremendous change in political issue or economic event to a certain level; the investors decrease the proportion of home asset and increase the proportion of foreign asset. The numerical result shows that home bias holds when the home event risk does not happen. Also when there is the home event risk, the relative standard deviation on both asset returns and the jump size play a deterministic role on portfolio weights.
[...] In Table throughout the calculation, by differentiating the investor terminal wealth with * and with respect to the risk aversion parameter respectively, the investors take the portfolio choice as significant foreign bias under the condition 1 and risk 2 respect to portfolio weight aversion parameter from 0.5 to 5 with one jump a year and jump size - 0.5 as the static result 0 For the same condition when jump-frequency increases to 10 years, the investor takes the portfolio decision on home bias ( ) except risk aversion 0.5 with 0.5 * f = 1.5 which home portfolio weight * However, under previous conditions the optimal portfolio weight on home asset with respect to the parameters implies the comparative static result as To illustrate this result, Figure 1 graphs the optimal portfolio weight on home asset as a function of the size of price jumps for risk aversion 0.5 on Panel A and and f and 10 respectively, as for risk aversion 3 on Panel C and f = 2. [...]
[...] Because information is not sufficiently transparent to foreign assets, the ratio of standard deviation on foreign asset return to the standard 1 f F deviation on home asset returns becomes greater than one implies the relationship f * f , where 1 between home portfolio weight and the ratio being the formula as If the ratio of standard deviation on both asset returns f increases to the limit, f and there 1 1 ( / 2 is no short position, then the optimal home portfolio weight approaches to one, Otherwise, borrowing policy can be accepted, and then the optimal home portfolio weight will be greater than one, holds. [...]
[...] The next section presents the model that describes the return of home asset price process with event-risk and the return of foreign asset price process with information filtration. Section 3 establishes the optimal portfolio and provides analytical solutions to the optimal portfolio choice problem for some specific cases. Section 4 provides numerical results and examines the implications for optimal portfolio decision. Section 5 summarizes the results and makes concluding remarks The Basic Model For simplicity, suppose there are two countries, Home and Foreign, each has a single risky asset, and that there is also a riskless asset. [...]