No place like home: Home bias and flight-to-quality in Group of Seven countries

Abstract

Home bias in investments (a major puzzle in international economics) is important because it can lead to inefficient portfolios, reduction of international trade, and exacerbation of financial contagion. In contrast, flight-to-quality (FTQ) acts to intensify international investments. We examine relationships between these two contrary phenomena in normal market conditions and exceptional periods, such as the 2008–2009 financial crisis, the 2013 taper tantrum episode, and the 2020 Covid-19 crisis in Group of Seven (G7) countries from 2004 to 2021. We apply a multivariate panel regression framework, using dynamic conditional correlations as measures of FTQ and multiple, robust specifications for the bias measure. Our findings indicate a positive relationship between home allocation and FTQ, this flight being oriented toward safe domestic assets. This result is surprising as it shows that home bias can have a beneficial side, as it can, by orienting safety-seeking investments domestically, counteract somewhat the aggravation of FTQ.