Role of risk aversion in countries' portfolio choices

Abstract

This study aims to investigate the role of endogenously changing risk aversion in the portfolio decisions of the countries in a heterogeneous agents setting. Data shows that developed countries tend to hold more risky assets whereas developing countries hold more risk-free assets. This suggests developed countries to be less risk averse compared to the developing countries. This paper analyzes the role of risk aversion, which changes endogenously depending on the growth rate deviations from the expected growth rate, in the asset demands of countries. Therefore this paper seeks to answer how the asset demands change as the developed countries become more risk averse. In this study, developed countries are assumed to be less risk averse; however, their coefficient of risk aversion increases when their future endowments fall below their expectations, which is an exogenous factor affecting the demand for the assets of the developing countries.