Abstract
This paper examines explanations for the equity home bias puzzle by utilizing the introduction of the euro in 1999 as a natural experiment. The introduction of the euro and the coordination of monetary policy across the Euro Area (EA) allows for a closer examination of this puzzle. Optimal foreign equity shares are derived from a version of the CAP-M and then empirically tested using detailed data from the IMF's Coordinated Portfolio Investment Survey covering the foreign equity holdings of 23 countries for the years 1997 and 2001–2004. While equity home bias has fallen worldwide over this period, by far the sharpest drop has been for intra-EA equity holdings with home bias falling from 68% to 29% between the pre and post-euro periods. Several explanations for this drop are tested, with the reduction in information asymmetries emerging as the most promising candidate.
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