Home Bias in Equities under New Open Economy Macroeconomics

This paper presents a potential solution to the home bias puzzle based on a new open economy macroeconomics model. In response to technology shocks, sticky prices generate a negative correlation between labor income and the profits of domestic firms, leading to home bias in equity holdings. In contrast, under flexible prices, labor income and the profits of the domestic firms are positively correlated. Returns on human capital and equities may be positively correlated under sticky prices when the source of shocks is monetary, but this risk is hedged through nominal assets rather than through equities. JEL classification: F31, F41, G11.