Abstract

We generalize the Cooper and Kaplanis (1994) methodology for estimating the costs that could reconcile international portfolio holdings with CAPM predictions. First, we can simultaneously estimate inward and outward investment costs and even interactions between home and host country. Second, the risk aversion parameter is estimated rather than postulated. Third, we control for exchange rate risk, inflation hedging, fixed-interest investments, round-tripping and omitted countries. Our estimates of implicit investment costs for the developed countries are much lower than those reported in prior studies. Over the period 2001-2004, our estimates of the average inward shadow costs range from 0.01 (US) to 37 (Indonesia) percent per annum. We find that the equity home bias is related to a mixture of market frictions, such as information asymmetries, institutional factors and explicit costs.

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