International portfolio nondiversification and exchange rate variability

Incomplete international portfolio diversification is implied by an equilibrium models of exchange rates with nontraded goods. The model can also explain the greater correlation between consumption and income within a country than between consumption across countries. Nontraded goods make more stringent the elasticity conditions required to explain exchange rate variability resulting from current productivity disturbances though not from disturbances to fiscal policies or the prospective return to investment. The model is also consistent with international real interest rate differentials, changes over time in the current account and relative wealth across nations, and observed time-series properties of exchange rates.