Home Bias in Global Bond and Equity Markets: The Role of Real Exchange Rate Volatility

48 Pages Posted: 7 Nov 2006

See all articles by Michael Fidora

Michael Fidora

European Central Bank (ECB)

Marcel Fratzscher

DIW Berlin; Centre for Economic Policy Research (CEPR)

Christian Thimann

AXA Group

Date Written: October 2006

Abstract

This paper focuses on the role of real exchange rate volatility as a driver of portfolio home bias, and in particular as an explanation for differences in home bias across financial assets. We present a Markowitz-type portfolio selection model in which real exchange rate volatility induces a bias towards domestic financial assets as well as a stronger home bias for assets with low local currency return volatility. We find empirical support in favour of this hypothesis for a broad set of industrialised and emerging market countries. Not only is real exchange rate volatility an important factor behind bilateral portfolio home bias, but we find that a reduction of monthly real exchange rate volatility from its sample mean to zero reduces bond home bias by up to 60 percentage points, while it reduces equity home bias by only 20 percentage points.

Keywords: home bias, exchange rate volatility, risk, portfolio investment, global financial

JEL Classification: F30, F31, G11, G15

Suggested Citation

Fidora, Michael and Fratzscher, Marcel and Thimann, Christian, Home Bias in Global Bond and Equity Markets: The Role of Real Exchange Rate Volatility (October 2006). ECB Working Paper No. 685, Available at SSRN: https://ssrn.com/abstract=936640 or http://dx.doi.org/10.2139/ssrn.936640

Michael Fidora (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 5713 (Phone)

Marcel Fratzscher

DIW Berlin ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Christian Thimann

AXA Group ( email )

25 avenue Matignon
Paris, 75008
France

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