International capital flows when investors have local information

While international capital flows have increased dramatically over the past two decades, from a risk-sharing perspective, world capital markets do not appear highly integrated. Investors continue to hold disproportionately large claims to domestic output, fund domestic investment mostly out of domestic savings, and consume at very different rates than agents residing abroad. In this paper, we investigate investment behavior in a model in which agents have superior information regarding domestic returns than those overseas. We show that such a setting, when calibrated to U.S. macroeconomic data, offers a unified explanation for the three risk-sharing puzzles in an environment of active capital flows. Investors' cross-border trading serves to amplify, rather than dampen, cross-border consumption differences and domestic savings-investment correlations.