In a world of incomplete financial markets and home-biased preferences across countries, inter-temporal utility maximizing agents with relative risk aversion greater than unity would like to hold assets in differentdenomination corresponding to the sh...
In a world of incomplete financial markets and home-biased preferences across countries, inter-temporal utility maximizing agents with relative risk aversion greater than unity would like to hold assets in differentdenomination corresponding to the shares of goods produced in each country in the consumption basket for precautionary motive to stabilize their consumption over time because exchange rate fluctuations are far greater than changes in price level. They also have a consumption-risk hedging motive to hold consumption risk hedging assets when their returns have negative relations with future economic conditions. In addition, they have a speculative motive to hold assets with higher returns. Consumption risk premiums are incorporated into relative returns of the identical assets in different denomination, creating interest rate differentials and capital flows even when assets are identical except the denomination.