Foreign bias in institutional portfolio allocation: The role of social trust
72 Pages Posted: 12 Aug 2020 Last revised: 30 May 2023
Date Written: May 27, 2023
We study the role of social trust in the equity allocation decisions of global investors using a large sample of institutionally managed portfolios of 8,088 investors from 33 countries over the 2000–2017 period. The negative relation between social trust and foreign bias suggests that institutional investors from high-social trust countries are less prone to underinvesting in foreign equity. Our results provide credence to an information-based explanation, indicating that social trust reduces foreign bias by compensating the lack of information about foreign stock markets. Moreover, the eﬀect of social trust on foreign bias is stronger if host-country institutions are weaker, while it vanishes when the host country has a strong institutional framework. The informal institution of social trust can compensate for the lack of formal country-level institutions in international portfolio decisions. Finally, social trust is diﬀerent from mere “blind” trust because it helps investors to accomplish higher cross-country portfolio diversiﬁcation and an improved risk-return trade-oﬀ.
Keywords: Trust, foreign bias, portfolio diversiﬁcation, information asymmetry, institutional investors, culture
JEL Classification: G11, G14, G15, G23, Z1
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