Equity Home Bias Research Articles

Foreign ownership and financial information

PurposeThe purpose of this paper is to examine the foreign ownership patterns in local stocks in an emerging capital market, i.e. the Istanbul stock exchange (ISE), to derive insights into the linkage between foreign investors’ equity‐level preferences and the information provided by the corresponding firm's financial statements.Design/methodology/approachThe data consists of foreign ownership share in non‐financial stocks over the period 2004‐2008 in the ISE. Given the time‐series cross‐sectional span of our data set, we run our regression analyses of the foreign ownership of Turkish stocks on various firm‐specific financial characteristics.FindingsOur analyses suggest that foreign investors are more likely to hold shares in firms with larger market capitalization and those with low leverage and book‐to‐market ratios. Overall, the results provide suggestive evidence on the asymmetric information hypothesis between local and non‐local investors and, accordingly, useful insights into the equity home bias puzzle.Practical implicationsFrom a practical viewpoint, understanding the impact of firm‐level characteristics on foreign investors’ preferences may provide valuable insights about the reasons and timing of foreign inflows or outflows of capital, to people at managerial positions.Originality/valueThe examination of the foreign ownership at a security level is expected to contribute into the ongoing debate on the determinants of cross‐border portfolio holdings, in general, and the reasons of the persistent home bias worldwide, in particular.

What drives international equity and bond holdings? An empirical study

In this article, we explore tentatively and formally the differences between bond and equity home and foreign bias based on a large data set including developed and emerging markets for the period 2001 to 2010. We show that, unlike for equities, the international demand for bonds is mainly supply-side driven: bond home bias increases with a growth in public debt, while the underinvestment bias towards a foreign country's bonds decreases if this country issues more (sovereign) debt. This explains the absence for a negative time trend in bond home bias while equity home bias has decreased over time, and similarly a decrease in foreign bond bias, which is not observed for equities. Besides variables being significantly more, less or incompatibly important for bond versus equity investment bias, we also determine variables to be exclusively relevant for bonds, like sovereign credit ratings and bank credit supply.

TASTE SHOCKS, ENDOGENOUS LABOR SUPPLY, AND EQUITY HOME BIAS

The puzzling bias of equity portfolios toward domestic assets (equity home bias) remains substantial. This paper proposes a dynamic stochastic general equilibrium model and demonstrates that shocks to consumption tastes (taste shocks) are an effective explanation for the equity home bias puzzle. In the model, home assets provide insurance for home agents to hedge against domestic taste fluctuations, whereas such insurance cannot be offered by foreign assets. The empirical evidence shows that, in explaining equity home bias, hedging against consumption taste risks is more relevant than hedging against labor income risks or real exchange rate risks.

Home Bias in Open Economy Financial Macroeconomics

Home bias is a perennial feature of international capital markets. We review various explanations of this puzzling phenomenon highlighting recent developments in macroeconomic modeling that incorporate international portfolio choices in standard two-country general equilibrium models. We refer to this new literature as Open Economy Financial Macroeconomics. We focus on three broad classes of explanations: (i) hedging motives in frictionless financial markets (real exchange rate and nontradable income risk), (ii) asset trade costs in international financial markets (such as transaction costs or differences in tax treatments between national and foreign assets), and (iii) informational frictions and behavioral biases. Recent theories call for new portfolio facts beyond equity home bias. We present new evidence on cross-border asset holdings across different types of assets: equities, bonds and bank lending and new micro data on institutional holdings of equity at the fund level. These data should inform macroeconomic modeling of the open economy and a growing literature of models of delegated investment. (JEL E13, F41, G11, G12, G15)

Real effects of financial market integration: does lower home bias lead to welfare benefits?

This paper proposes equity home bias as a proxy for financial integration in the ongoing empirical debate on the impact of financial integration on economic growth. In integrated markets, investors are expected to take full advantage of the potential for international diversification. The extent of equity home bias (i.e. overinvesting in domestic stocks and foregoing gains from international diversification) provides a relevant quantity-based measure of financial integration. Using different techniques to compute home bias, this paper investigates whether countries with lower home bias experience faster economic growth. Additionally, the analysis extends to the link between (decreasing) home bias and international risk sharing and income inequality. The results suggest that financial integration, proxied by the decreasing equity home bias, is positively associated with economic growth and international risk sharing. At the same time, it appears that higher financial integration pairs with higher income inequality.

Do they trade as they say? Comparing survey data and trading records

This article is about three widespread and far-reaching mistakes in financial markets, namely, the Equity Home Bias, Anchoring and Herding. We use a combination of two different sources, survey answers and actual trading patterns, in order to analyze those mistakes empirically. This two-pronged approach allows us to discover interrelations between talk and action and provides a robustness check for our findings. Equity Home Bias is more predominant in real trading than investors admit in the questionnaire. In addition to domestic stocks, German investors also overweight Non-German Eurozone stocks. Consequently, investors hold an astonishing 82.13 per cent of their portfolio in stocks denominated in Euro. Anchoring in the survey is positively correlated with the Disposition Effect in actual trading. We ask investors if they allow themselves to be influenced by others, and we demonstrate that there is a positive link between affirmative answers and Herding in real action. In addition, we study whether behavioral differences exist between various socio-demographic groups. Higher educated investors are less inclined to exhibit the Equity Home Bias, Anchoring and Herding. Whereas gender hardly influences biases, interestingly, age is positively related to Equity Home Bias but negatively related to the other two biases.

The Home(-Sickness) Bias of Foreign Holdings

The well documented \Equity home bias puzzle refers to the fact that investors tend to hold poorly diversied portfolios by favoring domestic stocks over international stocks. However, I show that even holdings of international stocks exhibit a form of home bias. I nd that U.S. mutual funds invest signicantly more in countries that have a strong associated ethnic group population near the funds’ oces. Mutual funds that take advantage of the information generated by the local ethnic groups out-perform otherwise similar funds by more than 1.4% per quarter in their foreign holdings. This paper documents a new form of home-bias, shed light on a new information channel for foreign investment decisions, and contribute to the debate on whether mutual fund managers have skills.

Why Did the Equity Home Bias Fall During the Financial Panic of 2008

Theories of home bias and of portfolio choice under uncertainty both predict that the home bias should increase during a financial crisis. In contrast to these theories, using a sample of 45 countries, I document that the equity home bias fell during the financial panic of 2008. Disentangling the active and passive components of portfolio holdings, I find that investors actively increased their home bias, but passive valuation changes subsumed these trades and reduced the home bias. Across countries, portfolio rebalancing, increased information asymmetries, and familiarity bias played distinct roles in investors’ international portfolio reallocations during the crisis.

Is Increasing Financial Integration Related to Improved International Risk Sharing?

In order to answer the question whether more integrated financial markets are characterized by less international risk sharing we focus on the long-term evolutions of the intensively discussed anomalies of the equity home bias, used as indicator for financial integration, and the international risk sharing in consumption. Using panel-data regressions for 21 OECD countries from 1980 to 2010, we show that a less than average amount of equity home bias, e.g. higher than average amount of international income flows, is associated with more international risk sharing. Much of the increase in international asset positions came during the recent globalization period. More generally, by measuring financial integration by the index of the equity home bias, our results indicate that more financial integration goes hand-in-hand with more internationally shared risk. Our results are robust across countries and time.

Bond and Equity Home Bias and Foreign Bias: An International Study

In this paper we explore tentatively and formally the differences between bond and equity home and foreign bias based on a large dataset including developed and emerging markets for the period 2001 to 2010. We show that, unlike for equities, the international demand for bonds is mainly supply-side driven: bond home bias increases with a growth in public debt, while the underinvestment bias towards a foreign country’s bonds decreases if this country issues more (sovereign) debt. This explains the absence for a negative time trend in bond home bias while equity home bias has decreased over time, and similarly a decrease in foreign bond bias, which is not observed for equities. Besides variables being significantly more, less or incompatibly important for bond versus equity investment bias, we also determine variables to be exclusively significant for bonds. In contrast to Fidora et al. (2007), we do not find that exchange rate volatility has a greater impact on bond home bias than on equity home bias.

The impact of international portfolio composition on consumption risk sharing

Recent empirical work has shown that ongoing international financial integration facilitates cross-country consumption risk sharing. These studies typically find that countries with high equity home bias exhibit relatively low international consumption risk sharing. We extend this line of research and demonstrate that it is not only a country's equity home bias that prevents consumption risk sharing. In addition, the composition of a country's foreign asset portfolio plays an important role. Using panel-data regression for a group of OECD countries over the period 1980–2007, we show that foreign investment bias has additional explanatory power for consumption risk sharing.

Equity Home Bias and the Euro

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.

Equity home bias and corporate disclosure

I show that more comprehensive corporate disclosure reduces investors’ uncertainty about domestic companies’ payoffs at no cost, thereby decreasing investors’ equity home bias toward a country. Since investors should base their investment decisions on valid and easily interpretable company information only, more comprehensive disclosure will reduce the home bias only if domestic securities law is sufficiently stratified and domestic companies use international accounting standards. Using panel data for 38 countries from 2003 to 2008 I find that more comprehensive disclosure reduces investors’ home bias, though significantly only for countries that sufficiently enforce their securities law and implement international accounting standards.

Portfolio Home Bias and External Habit Formation

This paper challenges the consensus that hedging against real exchange rate risk is unable to account for the empirically observed level of equity home bias. I consider a general equilibrium model which features cross-country heterogeneity in conditional risk aversion, generated by the interaction of home bias in preferences and external habit formation. In equilibrium, financing home consumption entails hedging against increases in home conditional risk aversion. I show that if preferences are sufficiently home biased, an increase in home risk aversion leads to a relative appreciation of the home equity due to the impact of an endogenous, risk aversion-generated demand shock which appreciates the home good. Furthermore, the model generates realistic asset return dynamics, satisfying a long-standing need of the international finance literature.

The Ability of Global Stock Exchange Mechanisms to Mitigate Home Bias: Evidence from Euronext

This paper examines the effects on equity home bias of two mechanisms adopted by Euronext when it was formed by the merger of four European countries' stock exchanges in 2002. The two structural mechanisms are the integration of trading platforms across the four predecessor exchanges and the creation of named segments of the integrated exchange on which firms could voluntarily list by precommitting to enhanced disclosure and transparency. Employing a difference-in-differences research design using other European Union companies as a control group, we document that the integration of the Euronext market was associated with a reduction in home bias for firms listed on the named segments of the Euronext exchange, but not for the nonsegment Euronext firms. Our results suggest that the reduction in transaction costs from the integration of the trading platforms did not make the nonsegment Euronext firms more attractive to the specific investors for whom the transaction costs were reduced. On the other hand, the decrease in information costs due to the precommitments to enhanced transparency made the segment firms more attractive to all categories of foreign investors, consistent with the information costs hypothesis. This paper was accepted by Mary Barth, accounting.

The Ability of Global Stock Exchange Mechanisms to Mitigate Home Bias: Evidence from Euronext

This paper examines the effects on equity Home Bias of two mechanisms adopted by Euronext when it was formed by the merger of four European countries' stock exchanges in 2002. Home Bias is the well-documented tendency of investors everywhere to over-invest in domestic securities relative to optimal portfolio diversification. These two mechanisms are the integration of trading platforms across the four national predecessor exchanges, and the creation of named segments of the new exchange on which firms could voluntarily list by pre-committing to enhanced disclosure and transparency. We test for changes in Home Bias associated with each mechanism by examining changes in domestic and foreign ownership between Euronext firms that joined the named segments and those that did not, controlling for contemporaneous political and financial developments in the Europe Union by including other EU firms as a benchmark. Overall, we find no diminution of Home Bias for the non-segment Euronext firms, but significant increases in all categories of foreign holdings relative to domestic holdings for the segment Euronext firms. Our results indicate that the segmentation mechanism of voluntary pre-commitment to enhanced financial reporting and corporate governance has the potential to reduce Home Bias for firms listed on the integrated global capital markets.

Immigration and equity home bias

Why do investors hold such large positions in domestic equity when there are gains to be made from international diversification? This equity home bias puzzle has received considerable attention in the literature, with asymmetric information on domestic and foreign assets (whether by individual choice or by market imperfection) emerging as the most plausible explanation. What happens when we consider a subset of investors whose information sets are closer to investors in foreign countries? I assess the relationship between immigration and equity home bias and find that inward migration is positively correlated with increased foreign equity positions and reduced home bias. Looking across income groups, outward migration reduces home bias for relatively rich countries, but may actually increase home bias when migration occurs to or from a developing country. These results suggest that immigration generates a positive externality of increased information flows for developed countries, but not for developing nations. The effects of immigration on investment are strongest within the Euro-Zone, suggesting that this positive externality of immigration is largest when barriers to portfolio diversification (such as currency risk) are lowest.

The Geographic Origin of Order Flow and Price Discovery

This study exploits a unique dataset to determine the relative contribution to price discovery of order flow originating from geographically dispersed ASX servers. It is found that the transactions of traders on the Sydney, Chicago and London servers have a significant impact on price volatility. Trades initiated on the Sydney and Chicago servers incur lower pre-trade transaction costs, pay a lower premium to liquidity providers, and have a higher price impact. Traders using the Sydney and Chicago servers contribute significantly to price discovery on the local Australian market. Our results imply that foreign investors can differ in their private information endowments, and collectively contribute to the market efficiency of local markets even when their individual impact is small. Our findings extend the previous literature on home equity bias and may explain the conflicting evidence over whether foreign or local investors are better informed.

Governance, monitoring and foreign investment in Chinese companies

This paper examines corporate governance and foreign equity home bias in Chinese companies. Free float measures are employed to account for bias introduced by insider control. It is found that foreign ownership relative to free float is negatively impacted by legal persons (large domestic cross company) holdings and positively related to large foreign institutional holdings, with the implication that the latter provide a monitoring function that reduces agency problems. Foreign ownership relative to free float is negatively related to firm size, possibly due to quasi government being the primary influence over insider control.

Equity home bias, incomplete financial markets, and nominal rigidities

Abstract This paper analyzes optimal portfolio decisions in a monetary open‐economy framework. It is found that market completeness and the specific form of nominal rigidities, namely, nominal price vs. nominal wage rigidities, matter for justifying the observed structure of equity holdings. When markets are complete, sticky prices generate a negative correlation between the non‐diversifiable labour income and the profit of domestic firms with respect to the productivity shocks, which explains why households invest little abroad. In contrast, when markets are incomplete, rigidities in goods prices result in a counterfactual ‘super home bias’, because domestic equities provide a good hedge against not only the labour income risk but also the relative price risk. Wage rigidities, however, have the opposite effect. Therefore, nominal rigidities in both goods prices and wage rates are needed to address the empirical composition of gross equity positions under incomplete markets.