Home Bias and High Turnover Reconsidered

Abstract

That foreign equities are underweighted but overtraded has become a stylized fact of international\nfinance. Since stylized facts drive research, theoretical models have been developed to explain the puzzling\ncoexistence of home bias and high turnover, and researchers have dismissed transaction costs as a plausible\nexplanation of home bias. I show, however, that part of the puzzle—very high turnover rates on foreign\nequity portfolios—is based on inaccurate estimates of cross-border holdings. Foreign turnover rates\ncalculated using information from comprehensive benchmark surveys on cross-border holdings are much\nlower than previously reported and comparable to domestic turnover rates. Thus, researchers should no\nlonger develop theoretical models to explain the coexistence of home bias and high turnover, and the\nrelationship between transaction costs and home bias warrants reexamination. On the latter point, the basic\nintuition from Tesar and Werner (1995) that transaction costs do not help explain the observed home bias\nis confirmed using actual data on transaction costs in 41 markets.