Non-traded Goods, Transaction Costs, and Equity Home Bias Puzzle

The fact that people prefer to hold domestic equities than foreign ones is still a puzzle for most economists. Although many factors are seemed to be reasonable explanations, two factors, non-traded goods and transaction costs, are usually regarded as the main ones to explain the puzzle. In spite of their importance, the question of which factor has better ability of explaining the puzzle has been the central issue among economists for a long period. In this paper, we will not only try to clarify the issue by examining the role of each factor playing in the puzzle, but also attempt to find out the reasons of disagreements among economists. A modern intranational macroeconomics approach will also be adopted to verify the discussion in this paper. Without surprise, it seems that a model with transaction costs has better ability to explain the puzzle since it's more general in classifying the tradability of goods