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Understanding international portfolio diversification and turnover rates

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Abstract

This paper argues that international trading costs of a fixed type can help explain home bias in international equities markets. While the stylized fact of high trading turnover in foreign holdings has been interpreted as evidence against international trading costs, we show that this argument only applies to costs that are proportional to trade, and not to fixed costs of entering the foreign market. After documenting that the home bias and turnover stylized facts remain valid in recent data, the paper constructs a simple portfolio allocation model with various configurations of trading costs. A configuration with per-unit costs heterogeneous among agents and a homogeneous fixed cost is found to replicate the pair of stylized facts.

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