Can trade costs in goods explain home bias in assets?

A debate has raged in the general equilibrium literature on the impact of trade costs on portfolio home bias. In all of these models there is a simple, easily observed covariance–variance ratio. We compute this term using data on real exchange rates and asset returns. The resulting portfolio home bias is close to zero, implying that GE models that create home bias through trade costs are not grounded in empirical reality. Our results enable the GE literature to move forward, but in a way in which the theoretical models are not at odds with an easily observed empirical regularity.