Home Bias and Expected Returns: A Structural Approach
43 Pages Posted: 25 Feb 2021 Last revised: 21 Jun 2022
Date Written: February 23, 2021
We study the effect of the home bias on international asset pricing by extending the core-satellite approach of active asset allocation to an equilibrium analysis. In this framework, investors combine a common core portfolio with an active investment in their home asset. In equilibrium, the core portfolio will deviate from the global market portfolio in characteristic ways, which we exploit to propose a new test of the home premium in expected returns. Unlike previous findings, our evidence suggests that the premium is almost negligible even though the home bias is substantial. This result is mainly driven by the generally high correlation of index returns and the distribution of the relative level of the home bias across countries.
Keywords: Home bias, Asset pricing, International diversification, Implied expected return, Core-satellite approach, Home preferences, Equilibrium model
JEL Classification: G11, G12, G15, G02, F30
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