What Determines the Domestic Bias and Foreign Bias? Evidence from Mutual Fund Equity Allocations Worldwide
Posted: 13 Aug 2004
This study analyzes the detailed equity holdings of over 20,000 mutual funds from 26 developed and developing countries. Of particular interest is that we examine how this huge number of funds allocates their money between domestic and foreign equity markets and what factors determine the distribution of their asset allocations worldwide. We find robust evidence that mutual funds, in aggregate, allocate disproportionately a larger fraction of wealth to domestic than foreign stocks. The results indicate that the stock-market development and familiarity variables exhibit significant, but asymmetric, effects on the domestic bias (domestic investors over-weighting the local markets) and foreign bias (foreign investors under- or over-weighting the overseas markets). When a market is more developed, or is closer in terms of physical distance or common language, this attracts foreign investors to the home country (less foreign bias) and, in turn, fewer domestic investors are found to hold local equities (less home bias). Furthermore, we find that variables such as economic development, capital controls, and withholding taxes also have significant, but smaller, effects on the investment decisions of foreign investors and not of domestic investors.
Keywords: Home bias, mutual funds, institutional investors, diversification
JEL Classification: G11, G15, F21
Suggested Citation: Suggested Citation