Wages, profits and the international portfolio puzzle

This paper investigates the impact of fluctuations in the return to human capital on the composition of international asset portfolios. We adopt a continuous-time VAR model of international portfolio choice which allows for intertemporal interactions between wage rates and capital returns. Applying the model to a large set of OECD countries, our findings account for an average bias of about 30 percentage points toward domestic securities. The results are quantitatively similar both when a 'fundamentals' approach is adopted to compute the returns to domestic capital from data on aggregate operating surpluses, and when data on financial returns are used to evaluate the overall payoff of a claim on a country's productive resources.