Valuation effect, heterogeneous investors and home bias

This paper examines the U.S. valuation e§ect (VE) on empirical and theoretical grounds. Theempirical results show the importance of the VE for the U.S. during 1976-2015. In particular, thereturn di§erential between U.S. assets and liabilities averaged 3.5% and the portfolio investment(PI) was the main contributor to the return di§erential. Furthermore, the decomposition ofthe PI return di§erential into capital gains and exchange rate áuctuations provides evidencethat most of the valuation changes came from asset price movements and that there was aU.S. dollar appreciation in periods of high asset price volatility. I use the portfolio balanceapproach in a general equilibrium framework to investigate the underlying factors of the VEchannel. The microfoundations for the portfolio composition allow me to characterize the returndi§erential as an equilibrium outcome and to derive the home bias restriction. This constraintnot only restrains the solution space of the investorsíoptimization problem but also increases thedisparity of the attitude towards risk between domestic and foreign investors. For this reason,the numerical simulation shows that the standard assumptions of homogeneous investors andlogarithmic utility function lead to optimal shares that are inconsistent with the data. Finally,the model is able to replicate some empirical facts of the U.S. VE, speciÖcally the appreciationof the U.S. dollar in times of high volatility and the decrease of the return di§erential after thecrisis in 2007. The latter could be explained by higher risk aversion and/or higher volatility ofthe foreign asset