The Effect of Familiarity with Foreign Markets on Institutional Investors’ Performance
44 Pages Posted: 1 Feb 2017 Last revised: 19 Aug 2017
Date Written: July 31, 2017
Empirical studies document that investors typically deviate significantly from a globally market value weighted portfolio, concentrating their portfolio holdings in securities domiciled in their home country and in familiar foreign markets. Evidence that home country concentration stems from an information advantage is mounting, but it is not known whether investors’ foreign portfolio concentration extends the local market information advantage to familiar foreign markets. Using a comprehensive sample of foreign portfolio allocations of institutional investors, we identify a familiarity effect where, on average, investors achieve higher risk-adjusted returns in familiar foreign markets. The familiarity effect depends on investor skill. According to our investor skill metric, high skill investors outperform low skill investors; and low skill investor performance suffers especially in unfamiliar foreign markets. These new findings on better performance outcomes in familiar foreign markets suggest that investors have an information advantage that is rationally exploited in familiar foreign markets.
Keywords: Institutional investors, Information advantage, Familiarity, Concentration, Cultural distance, Geography
JEL Classification: G11, G14, G15, G23, Z10
Suggested Citation: Suggested Citation