International portfolios in the new open economy macroeconomics model

This thesis employs recently developed numerical approximation methods to study international portfolio diversification in the dynamic stochastic general equilibrium New Open Economy Macroeconomics (NOEM) model. The theoretical model features capital accumulation, nominal price rigidity, monetary policy shocks, and incomplete asset markets. The model can account for the observed home bias in equity portfolio. The steady state equilibrium portfolio is sensitive to the model's specifications, particularly the degree of price stickiness and the completeness of asset markets. The NOEM model with three types of shocks -- investment specific technology, total factor productivity, and monetary policy -- can generate sizeable volatility in portfolio holdings and asset trades. Monetary policy shocks play an important role in determining the steady state equilibrium portfolio as well as influencing portfolio dynamics. Theoretical responses of dynamic portfolio holdings are empirically tested using the Structural Vector Auto Regression framework on US data. The benchmark period is 1982:Q2 to 2007:Q4, however, the full sample from 1960:Q1 to 2007:Q4 is also examined. Empirical responses are consistent with theoretical predictions. Comparison of empirical findings of different time periods illustrates the possibility that the liberalization of financial markets has changed the nature of international asset diversification.