Why Has the U.S. Foreign Portfolio Share Increased?

Abstract

For decades the U.S. foreign portfolio share remained relatively constant; yet from 1994 to 2010, the share of equity wealth U.S. investors allocated to foreign markets nearly doubled. Using a sample of monthly bilateral equity holding between investors in the United States and 46 countries, I find that most of the growth in the U.S. foreign portfolio share has been passive. As U.S. stocks — the assets that U.S. investors tend to overweight — fell relative to the world market portfolio, U.S. investors allowed their foreign holdings to passively appreciate. Traditional portfolio choice theories predict that the gains to holding foreign equity are increasing in wealth. Alternative theories of ambiguity aversion and behavioral investment predict that uncertainty and sentiment impact international portfolio choice as well. Controlling for the passive change in the U.S. foreign portfolio share, I find evidence consistent with changes in foreign wealth and sentiment sending U.S. investors abroad and changes in uncertainty sending U.S. investors home.

Keywords: Home Bias, International Asset Pricing, Uncertainty Aversion, Behavioral Finance

JEL Classification: G15, G11, G12, G02, F30