Information Acquisition, International Under-Diversification and Portfolio Performance of Institutional Investors
57 Pages Posted: 10 Mar 2012
Date Written: January 9, 2012
Traditional portfolio theory predicts that investors’ portfolios should be diversified across international markets. In contrast, empirical studies document that investors are more likely to invest in their home country and in foreign markets that are culturally similar to and geographically nearby the investor’s home market, which implies that investors do not take advantage of international diversification opportunities. However, more recent theoretical studies show that portfolios can be under-diversified but optimal, if they are based on information advantage. This study examines empirically whether observed home bias and international under-diversification is a rational choice attributed to information advantage. We test whether 1) institutional investors with concentrated international holdings outperform internationally diversified investors, and 2) foreign investors with information advantage, measured by cultural and geographic proximity to the target market, outperform other foreign investors. Using the United States as a target market, we document that neither US investors nor foreign investors with concentrated holdings in US securities outperform other, more internationally diversified investors. In fact, foreign investors with more concentrated holdings in the US market underperform foreign investors with less concentrated holdings in the US market. These results contradict the idea that home-biased and internationally under-diversified portfolios are mean-variance efficient due to the economies of scale and specialization. However, the second part of the analysis shows that cultural similarity and geographic proximity to the US enhance investors’ performance in US securities, consistent with the idea that cultural and geographic closeness are associated with information advantage. We contribute to the existing literature by (1) exploring the link between performance and market concentration in an international setting, and (2) examining institutions’ performance conditioning on investors’ home-country characteristics.
Keywords: under-diversification, home bias, performance, institutional investor, cultural distance
JEL Classification: G11, G15, G20
Suggested Citation: Suggested Citation