Multinational Production, Risk Sharing, and Home Equity Bias

Abstract

We study the consequences of offshoring for international equity portfolios, risk sharing, and the international transmission of technology and government spending shocks. We show analytically that serving foreign markets by producing locally can substitute for international asset trade and terms of trade adjustment in delivering perfect risk sharing across countries: Offshore production implies that the consumption differential is tied to the real exchange rate even if the optimal equity portfolio is fully home-biased and the elasticity of substitution between domestic and foreign goods in consumption is different from one. Net foreign assets do not move in response to shocks. We investigate how the extent to which firms use source- versus host-country technology when producing abroad matters for the international transmission of shocks. A numerical illustration allows us to compare transparently the properties of our model to those of the alternative environment in which firms serve foreign markets by exporting.