Standard theoretical models predict that domestic residents should diversify their portfolios into foreign assets much more than observed in practice. Whether this lack of diversification is important depends upon the potential gains from risk-sharing. General equilibrium models and consumption...

Under conventional notions about rational expectations and market efficiency, expected returns differ from the actual expost returns by a forecast error that is uncorrelated with current information. In this paper, we describe how small departures from conventional notions of rational...