Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/303525 
Year of Publication: 
2024
Series/Report no.: 
New Working Paper Series No. 346
Publisher: 
University of Chicago Booth School of Business, Stigler Center for the Study of the Economy and the State, Chicago, IL
Abstract: 
Observed international investment positions and cross-country heterogeneity in rates of return to capital are hard to reconcile with frictionless capital markets. In this paper, we develop a theory of international capital allocation: a multi-country dynamic spatial general equilibrium model in which the entire network of cross-border investment is endogenously determined. Our model features cross-country heterogeneity in fundamental risk, a demand system for international assets, and frictions that cause segmentation in international capital markets. We measure frictions affecting international investment and apply our model to data from nearly 100 countries, using a new dataset of international capital taxes and cultural, geographic and linguistic distances between countries (geopoliticaldistance.org). Our model performs well in reproducing the composition of international portfolios, the cross-section of home bias and rates of return to capital, and other key features of international capital markets. Finally, we carry out counterfactual exercises: we show that barriers to international investment reduce world output by almost 7% and account for nearly half of the observed cross-country differences in capital stock per employee.
Subjects: 
Capital Allocation
Cultural Distance
Geography
Information Frictions
International Finance
International Investment
Misallocation
Open Economy
Rational Inattention
JEL: 
E22
E44
F2
F3
F4
G15
O4
Document Type: 
Working Paper

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