The Equity Home Bias Puzzle: A Survey

143 Pages Posted: 18 Jan 2014

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Piet Sercu

FEB at KU Leuven

Rosanne Vanpee

KU Leuven Faculty of Economics and Business

Date Written: December 31, 2013

Abstract

Home bias -- the empirical phenomenon that investors assign anomalously high weights to their own domestic assets -- has puzzled academics for decades: financial theory predicts that an internationally well diversified portfolio of stocks and short-term bonds can reduce risk significantly without affecting expected return. Although the globalization of international equity markets has increased international investments, equity portfolios remain severely home biased today, and no single explanation seems to solve the puzzle completely. In this paper, we first provide a thorough description of the equity home bias phenomenon by defining, discussing, and applying the competing measures and presenting some estimates of the costs of under-diversification. Second, we evaluate the explanations for the equity home bias proposed in the literature such as information asymmetries, behavioral aspects, barriers to foreign investment, and governance issues, and conclude that each explanation on its own falls short, suggesting that the equity home bias probably reflects a combination of factors. Lastly, we review the implications of international under-diversification for portfolio formation and the cost of capital of companies.

Keywords: Equity, home bias, international portfolio choice

JEL Classification: G11, G15, G02

Suggested Citation

Cooper, Ian Anthony and Sercu, Piet M. F. A. and Vanpee, Rosanne, The Equity Home Bias Puzzle: A Survey (December 31, 2013). Foundations and Trends in Finance, Vol. 7, No. 4, 2013, Available at SSRN: https://ssrn.com/abstract=2380337

Ian Anthony Cooper (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 171 262 5050 (Phone)

Piet M. F. A. Sercu

FEB at KU Leuven ( email )

Naamsestraat 69
Faculty of Economics and Business
Leuven, 3000
Belgium
+32 16 32 67 56 (Phone)
+32 16 32 67 32 (Fax)

Rosanne Vanpee

KU Leuven Faculty of Economics and Business ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

HOME PAGE: http://scholar.google.be/citations?user=yhAZIHEAAAAJ&hl=en

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