“Home Bias Puzzle”. Is It a Puzzle or Not?
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Abstract
The benefits of international diversification have been well documented over the last decades. Despite this however, investors seem unwilling to exploit this opportunity in order to limit the risk of their portfolio and they continue to invest the largest percentage of their wealth in domestic assets. This phenomenon is called the Home Bias Puzzle and the given explanations for it have not been empirically proven to justify its existence.
The purpose of this paper is to present a literature review on the opinions and possible explanations about the home bias puzzle. Furthermore, concluding, it will try to answer whether the home bias puzzle is a puzzle or not.
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References
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Admati, A. (1985), “A Noisy Rational Expectations Equilibrium for Multi-Asset Securities Markets”, Econometrica, Vol. 53, pp. 629-657.
Baxter, M. and Jermann, U. J. (1997), “The International Diversification Puzzle is Worse than You Think”, American Economic Review, Vol. 87, pp. 170-181.
Baxter, M., Jermann, U. J. and King R. G. (1998), “Nontraded Goods, Nontraded Factors, and International Non-Diversification”, Journal of International Economics, Vol. 44, pp. 211-229.
Brennan, M. J. and Cao, H. H. (1997), “International Portfolio Investment Flows”, Journal of Finance, Vol. 52, pp. 1581-1880.
Carmichael, B. and Coёn, A. (2003), “International Portfolio Choice in an Overlapping Generations Model with Transaction Costs, Economic Letters, Vol. 80, pp. 269-275.
Coёn, A. (2001), “Home Bias and International Capital Asset Pricing Model with Human Capital”, Journal of Multinantional Financial Management, Vol. 11, pp.497-513.
Cooper, I. and Kaplanis, E. (1994), “Home Bias in Equity Portfolios, Inflation Hedging, and International Capital Market Equilibrium, Review of Financial Studies, Vol. 7, pp. 45-60.
Coval, J. D. and Moskowitz, T. J. (1999), “Home Bias at Home: Local Equity Preference in Domestic Portfolios”, Journal of Finance, Vol. 54, pp. 2045-2073.
French, K. and Poterba, J. (1991), “International Diversification and International Equity Markets”, American Economic Review, Vol. 81, pp. 222-226.
Gehrig, T. (1993), “An Information Based Explanation of the Domestic Bias in International Equity Investment”, Scandinavian Journal of Economics, Vol. 95, pp. 97-109.
Glassman, D. A. and Riddick, L. A. (2001), “What Causes Home Asset Bias and How Should It Be Measured?”, Journal of Empirical Finance, Vol. 8, pp. 35-54.
Gorman, L. R. and Jorgensen, B. N. (2002), “Domestic Versus International Portfolio Selection: A Statistical Examination of the Home Bias”, Multinational Finance Journal, Vol. 6, pp. 131-166.
Grubel, H.G (1968), “Internationally Diversified Portfolios: Welfare Gains and Capital Flows”, American Economic Review, Vol. 58, pp.1975-1999.
Hellwing, M. F. (1980), “On the Aggregation of Information in Competitive Markets”, Journal of Economic Theory, Vol. 22, pp.477-498.
Kang, J. and Stulz, R. M. (1997),”Why is There a Home Bias?”, Journal of Financial Economics, Vol. 46, pp. 3-28.
Levy, H. & M. Sarnat (1970), “International Diversification of Investment Portfolios”, American Economic Review, Vol. 60, pp. 668-675.
Lewis, K. (1999), “Trying to Explain Home Bias in Equities and Consumption”, Journal of Economic Literature, Vol. 37, pp. 571-608.
Markowitz, H.M. (1952), “Portfolio Selection”, Journal of Finance, Vol. 7, pp.77-91.
Mehra, R. and Prescott, E. C. (1985), “The Equity Premium: A Puzzle”, Journal of Monetary Economics, Vol. 15, pp. 145-161.
Obstfeld, M. and Rogoff, K. (1996), Foundations of International Macroeconomics, MIT Press, Cambridge, MA.
Serrat, A. (1995), “A Dynamic Model of International Risk Sharing Puzzles”, MIT Working Paper.
Shiller, R. J., Kon-Ya, F. and Tsutsui, Y. (1991), “Speculative Behavior in the Stock Markets: Evidence from the U.S and Japan”, NBER Working Paper 3613.
Solnik, B. H. (1978), “International Parity Conditions and Exchange Risk”, Journal of Banking and Finance, Vol. 2, pp. 281-293.
Solnik, B. H. (1996), International Investments, Addison Wesley, Reading, MA
Stockman, A. and Dellas, H. (1989), “International Portfolio Nondiversification and Exchange Rate Volatility”, Journal of International Economics, Vol. 26, pp. 271-289.
Tesar, L. and Werner, I. (1995), “Home Bias and High Turnover”, Journal of International Money and Finance, Vol. 14, pp. 467-492.
Uppal, R. (1993), “A General Equilibrium Model of International Portfolio Choice”, Journal of Finance, Vol. 48, pp. 529-552.
Admati, A. (1985), “A Noisy Rational Expectations Equilibrium for Multi-Asset Securities Markets”, Econometrica, Vol. 53, pp. 629-657.
Baxter, M. and Jermann, U. J. (1997), “The International Diversification Puzzle is Worse than You Think”, American Economic Review, Vol. 87, pp. 170-181.
Baxter, M., Jermann, U. J. and King R. G. (1998), “Nontraded Goods, Nontraded Factors, and International Non-Diversification”, Journal of International Economics, Vol. 44, pp. 211-229.
Brennan, M. J. and Cao, H. H. (1997), “International Portfolio Investment Flows”, Journal of Finance, Vol. 52, pp. 1581-1880.
Carmichael, B. and Coёn, A. (2003), “International Portfolio Choice in an Overlapping Generations Model with Transaction Costs, Economic Letters, Vol. 80, pp. 269-275.
Coёn, A. (2001), “Home Bias and International Capital Asset Pricing Model with Human Capital”, Journal of Multinantional Financial Management, Vol. 11, pp.497-513.
Cooper, I. and Kaplanis, E. (1994), “Home Bias in Equity Portfolios, Inflation Hedging, and International Capital Market Equilibrium, Review of Financial Studies, Vol. 7, pp. 45-60.
Coval, J. D. and Moskowitz, T. J. (1999), “Home Bias at Home: Local Equity Preference in Domestic Portfolios”, Journal of Finance, Vol. 54, pp. 2045-2073.
French, K. and Poterba, J. (1991), “International Diversification and International Equity Markets”, American Economic Review, Vol. 81, pp. 222-226.
Gehrig, T. (1993), “An Information Based Explanation of the Domestic Bias in International Equity Investment”, Scandinavian Journal of Economics, Vol. 95, pp. 97-109.
Glassman, D. A. and Riddick, L. A. (2001), “What Causes Home Asset Bias and How Should It Be Measured?”, Journal of Empirical Finance, Vol. 8, pp. 35-54.
Gorman, L. R. and Jorgensen, B. N. (2002), “Domestic Versus International Portfolio Selection: A Statistical Examination of the Home Bias”, Multinational Finance Journal, Vol. 6, pp. 131-166.
Grubel, H.G (1968), “Internationally Diversified Portfolios: Welfare Gains and Capital Flows”, American Economic Review, Vol. 58, pp.1975-1999.
Hellwing, M. F. (1980), “On the Aggregation of Information in Competitive Markets”, Journal of Economic Theory, Vol. 22, pp.477-498.
Kang, J. and Stulz, R. M. (1997),”Why is There a Home Bias?”, Journal of Financial Economics, Vol. 46, pp. 3-28.
Levy, H. & M. Sarnat (1970), “International Diversification of Investment Portfolios”, American Economic Review, Vol. 60, pp. 668-675.
Lewis, K. (1999), “Trying to Explain Home Bias in Equities and Consumption”, Journal of Economic Literature, Vol. 37, pp. 571-608.
Markowitz, H.M. (1952), “Portfolio Selection”, Journal of Finance, Vol. 7, pp.77-91.
Mehra, R. and Prescott, E. C. (1985), “The Equity Premium: A Puzzle”, Journal of Monetary Economics, Vol. 15, pp. 145-161.
Obstfeld, M. and Rogoff, K. (1996), Foundations of International Macroeconomics, MIT Press, Cambridge, MA.
Serrat, A. (1995), “A Dynamic Model of International Risk Sharing Puzzles”, MIT Working Paper.
Shiller, R. J., Kon-Ya, F. and Tsutsui, Y. (1991), “Speculative Behavior in the Stock Markets: Evidence from the U.S and Japan”, NBER Working Paper 3613.
Solnik, B. H. (1978), “International Parity Conditions and Exchange Risk”, Journal of Banking and Finance, Vol. 2, pp. 281-293.
Solnik, B. H. (1996), International Investments, Addison Wesley, Reading, MA
Stockman, A. and Dellas, H. (1989), “International Portfolio Nondiversification and Exchange Rate Volatility”, Journal of International Economics, Vol. 26, pp. 271-289.
Tesar, L. and Werner, I. (1995), “Home Bias and High Turnover”, Journal of International Money and Finance, Vol. 14, pp. 467-492.
Uppal, R. (1993), “A General Equilibrium Model of International Portfolio Choice”, Journal of Finance, Vol. 48, pp. 529-552.