Three essays on international financial markets

The financial integration across borders has been increasing dramatically over the past decades. Why has the bias of equity portfolios towards domestic assets (the "equity home bias" puzzle) remained substantial? The financial system has seen an unprecedented expansion in the role of credit, and long-run historical data have shown that the financial system itself is prone to generate economic instability. To what degree has the financial system impacted the real economy, especially regarding international trade? Chapters 1 and 2 study the home equity bias puzzle, and Chapter 3 examines the impact of financial shocks on exports.;Chapter 1 proposes a dynamic stochastic general equilibrium (DSGE) model in which shocks to consumption tastes ("taste shocks") are an effective explanation for the equity home bias. The mechanism is that home assets provide a nice insurance property, which is not offered by foreign assets, for home agents to hedge against domestic taste shocks. The model finds that home equity bias positively relies on the persistence and the volatility of domestic taste shocks, and endogenizing labor supply helps overturn many unrealistic implications of the existing models in which endowment economies are commonly assumed.;Chapter 2 is devoted to presenting empirical evidence on the impacts of taste shocks on international portfolio allocations. The model described above provides a structure with empirical implications, in that the equilibrium portfolio can be written as the sum of two conditional covariance-variance ratios based on a longrun horizon with all determinants observable. Using VAR estimation results, the paper then computes the two ratios and finds that the ratio for consumption taste risks, rather than the one for labor income risk, is in the line with the model prediction. The empirical evidence thus suggests that models based on hedging against taste risks are more consistent with data than competing models based on labor income risks.;Chapter 3, a joint work with Ching-Yi Lin, studies the impacts of credit crunch on the extensive margin and intensive margin of exports both empirically and theoretically. Panel regressions in the study reveal that a negative financial shock discourages exports by reducing the variety of goods exported as well as the export volume of each individual good. A DSGE model is developed to understand this finding, featuring financial shocks, enforcement constraint and firm entry. As the credit crunch happens, the costs of borrowing to finance firms' exports increase. It reduces individual firms' exports as well as aggregate exports and discourages firms' entry into the export market. The model can also explain the fact that trade dropped more than domestic production and GDP as observed in the most recent financial crisis.