Information Costs and Home Bias: An Analysis of U.S. Holdings of Foreign Equities

Abstract

Using a comprehensive new data set, we exploit the cross-sectional variation of U.S. holdings of equities in a wide range of countries to gain insight into the equity home bias phenomenon. We find that a direct barrier to international investment - restrictions on foreign ownership of equities - significantly affects the country distribution of U.S. equity holdings, but has only a small effect on the overall level of home bias. More important are information asymmetries due to the poor quality and low credibility of financial information in many countries. While no direct measure of information costs is available, some foreign firms have reduced these costs by publicly listing their securities in the United States, where investor protection regulations elicit standardized, credible financial information. We find that a proxy for the reduction in information asymmetries - the portion of a country's market that has a public U.S. listing - is a major determinant of a country's weight in U.S. investors' portfolios. Foreign countries whose firms do not alleviate information costs by opting into the U.S. regulatory environment are more severely underweighted in U.S. equity portfolios.

Keywords: Information asymmetries; Investor protection; Accounting standards; Portfolio choice

JEL Classification: G11, G15, M41, K22