Domestic Versus International Portfolio Selection: A Statistical Examination of the Home Bias

Multinational Finance Journal, Vol. 6, No. 3 & 4

36 Pages Posted: 21 Jul 2003

See all articles by Larry R. Gorman

Larry R. Gorman

California Polytechnic State University

Bjorn Jorgensen

London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Abstract

The observed international home bias has traditionally been viewed as an anomaly. We provide statistical evidence contrary to this view within a mean-variance framework. We investigate two methods of estimating the expected return and covariance parameters: (i) the Bayes-Stein "shrinkage" algorithm, and (ii) the traditional Markowitz approach. In in-sample tests, neither the Bayes-Stein tangency allocation vector, nor the Markowitz tangency allocation vectors are significantly different from a 100% domestic allocation (i.e. extreme home bias). The result is robust to the shorting of equity, and across foreign exchange hedge strategies. We also conduct out-of-sample tests with a view toward investment performance. We find that a 100% domestic allocation typically outperforms both the Bayes-Stein and Markowitz tangency portfolios. Overall, the theorized gains to international diversification appear difficult to capture in practice, and hence investors exhibiting a strong home bias are not necessarily acting irrationally.

Keywords: Portfolio allocation, home bias, foreign exchange hedging, international finance

JEL Classification: F3, G11, G12, G15

Suggested Citation

Gorman, Larry and Jorgensen, Bjorn N, Domestic Versus International Portfolio Selection: A Statistical Examination of the Home Bias. Multinational Finance Journal, Vol. 6, No. 3 & 4, Available at SSRN: https://ssrn.com/abstract=413981 or http://dx.doi.org/10.2139/ssrn.413981

Larry Gorman (Contact Author)

California Polytechnic State University ( email )

College of Business
Department of Finance
San Luis Obispo, CA 93407
United States
805-756-1312 (Phone)
805-756-1473 (Fax)

Bjorn N Jorgensen

London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )

Department of Accounting Room, OLD 2.17
Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://www.lse.ac.uk/accounting/people/bjorn-jorgensen

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