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Keywords:

  • capital flows;
  • diversification;
  • gravity model;
  • portfolio choice;
  • return chasing

Abstract

This paper addresses a correlation puzzle in the financial gravity literature by taking into account a return-chasing motive previously under-researched as determinants of cross-border asset holdings. I estimate a financial gravity equation to explain US investors' behaviour and confirm that even with the return chasing motive, the correlation puzzle remains unsolved. Furthermore, the data give a limited support for the return-chasing motive. I find that USA's foreign asset holdings cannot be well explained by the correlation structure and excess returns. Copyright © 2013 John Wiley & Sons, Ltd.