Institutional Determinants of International Equity Portfolios - A Country-Level Analysis

Abstract

Despite large potential gains international equity investment is less diversified across countries than predicted by the international version of the classical capital asset pricing model (ICAPM). This paper provides empirical evidence on the impact of capital market frictions on international equity portfolios using data on bilateral equity holdings. Three important findings are reported: First, the home bias in equities puzzle does not exist for all observed country pairs, instead a 'friendship bias' can be observed. Second, indirect barriers such as the degree of financial market development and especially information asymmetries have strong explanatory power, whereas direct barriers such as taxes and capital controls have almost no impact on the portfolio share of foreign equities. Third, diversification motives have an impact on the relevance of capital market frictions.