Bilateral Trade, Openness, and Asset Holdings

This paper analyzes the relationship between bilateral trade flows, trade openness, and asset holdings in a three-country stochastic general equilibrium model. The three-country model set-up enables me to disentangle the effects of bilateral trade flows and trade openness on bilateral portfolio patterns. I find that both factors independently influence bilateral asset holdings. Higher bilateral trade as well as higher trade openness lead to a higher bilateral foreign asset position. Furthermore, the model shows an interaction effect between these two factors, where increasing trade openness reduces the influence of bilateral trade flows on asset holdings. I provide supporting empirical evidence for these theoretical findings using a data set on the geographical composition of international portfolio holdings.