Home Bias In Investment Research Articles

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

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.

Local product market competition and investment home bias

Local product market competition introduces predation risk, which could lead firms to take advantage of local, non-industry investment options to avoid pressure from their local product market competitors. However, investment within competitive local product markets tends to be inefficient due to difficulties in obtaining information and coordinating actions. This inefficiency could extend to local, non-industry-specific investments, resulting in a negative effect of product market competition on a firm’s response to local, non-industry investment opportunities. Testing these two competing views, we find that firms in competitive local product markets show higher sensitivity to local, non-industry-specific investment signals, and that such sensitivity is associated with an increase in performance and market share. These results hold when addressing the potential endogeneity issue using an exogenous shock to local product market competition, a PSM technique, and an IV estimation. Furthermore, our results show that firms in competitive local product markets are also more likely to make local, non-industry acquisitions. Lastly, our results show that firms in competitive local product markets are more responsive to local, non-industry investment opportunities, primarily when they have low cash holdings, are financially unconstrained, or have little geographical diversification.

Firm listing status and the investment home bias

Are public firm investment rates more sensitive than private firm rates to new investment opportunities? We offer a new explanation for differences in public and private firm investment sensitivities: investment sensitivities differ because the type of investments favored by firms varies with their listing status. Specifically, we consider the geography of investment opportunities and find that private firms have a much stronger investment home-bias than similar public firms which makes their investment decisions more sensitive to local investment opportunities than public firms. Controlling for local investment opportunities explains four-fifths of the differential sensitivity between public and private firms not explained by more traditional measures of investment opportunities.

The Investment Home Bias with Peer Effect

Observed international diversification implies an investment home bias (IHB). Can bivariate preferences with a local domestic peer group rationalize the IHB? For example, it is argued that wishing to have a large correlation with the Standard and Poor’s 500 stock index (S&P 500 stock index) may induce an increase in the domestic investment weight by American investors and, hence, rationalize the IHB. While this argument is valid in the mean-variance framework, employing bivariate first-degree stochastic dominance (BFSD), we prove that this intuition is generally invalid. Counter intuitively, employing “keeping up with the Joneses” (KUJ) preference with actual international data even enhances the IHB phenomenon.

The Investment Home Bias with Peer Effect

Observed international diversification implies an investment home bias (IHB). Can bivariate preferences with a local domestic peer group rationalize the IHB? For example, it is argued that wishing to have a large correlation with the S&P 500 stock index may induce an increase in the domestic investment weight by American investors and, hence, rationalizes the IHB. While this argument is valid in the mean-variance framework, employing Bivariate First-degree Stochastic Dominance (BFSD), we prove that this intuition is generally invalid. Counter intuitively, employing “Keeping Up with the Joneses” (KUJ) preference with actual international data even enhances the IHB phenomenon.

Firm Listing Status and the Investment Home Bias

Prior research has found that public firm investment rates are more sensitive than private firm investment rates to new investment opportunities. We confirm these findings and offer a new explanation for this result. Public and private firm investment sensitivities differ because the types of investments favored by firms varies with their listing status. Private firms have a much stronger investment home-bias than similar public firms which makes their investment decisions more sensitive to measures of local, non-industry investment opportunities, but due to resource constraints less sensitive to firm- and industry-measures of investment opportunities. Controlling for both types of investment opportunities explains roughly four-fifths of the differential sensitivity of public and private firms to new investment opportunities.

What is the Economic Cost of the Investment Home Bias?

Overinvesting domestically is well known as an investment home bias (IHB). We define an economic home bias (EHB), whereby the IHB measures the investment weights and the EHB measures the economic cost induced by the IHB. We may have a large IHB and a negligible EHB. With the increase in the average correlation between foreign markets from 0.4 for the decade ending in 1988 to about 0.9 for more recent decades, the U.S. EHB is becoming negligible despite the domestic investment of 77.5%. Since 2009, the correlations have decreased, indicating that the HB puzzle is emerging once again.

Asset allocation and monetary policy: Evidence from the eurozone

The eurozone has a single short-term nominal interest rate, but monetary policy conditions measured by real short-term interest rates varied substantially across countries in the period 2003–2010. We use this cross-country variation in the (local) tightness of monetary policy to examine its influence on equity and money market flows. In line with a powerful risk-shifting channel, we find that fund investors in countries with decreased real interest rates shift their portfolio investment out of the money market and into the riskier equity market, causing significant equity price inflation in countries where investment home bias is the strongest.

What is the Economic Cost of the Investment Home Bias?

American investors tilt to overinvest domestically, well-known as a home bias puzzle. Hedging various types of domestic risks, differences in taxes and transaction costs, informational frictions and behavioral effects are commonly employed in an attempt to explain the home bias puzzle. We show in this study that even abstracting from the above factors, nowadays there is a simple rationalization for the home bias, let alone when these factors are also accounted for. We define economic home bias (EHB) to distinguish it from investment home bias (IHB), where the IHB measures investment weights and the EHB measures economic cost. We find that for reasonable degrees of risk aversion and with 25 years multivariate distribution, that the annual EHB loss is merely 0.1%, despite the large domestic overinvestment of about 40% in the US. Thus, with market globalization and high correlations, overinvesting domestically is not irrational implying that the home bias puzzle has vanished.

The Ecology of Crowdfunding: Global Bias Welcome in the Geography of Investments

This research investigates the global online appeal of crowdfunding —an open distributed financing mechanism enabled by the crowds that offers an alternative to traditional financial institutions, centralized and closed. An extensive body of literature posits the prevalence of the home bias or local bias anomaly in the geography of investments (e.g. Huberman 2001). However, much of the extant literature is based on equity-based studies within a single firm or a single country, within the realm of traditional financial institutions. Using a rich database of 390 crowdfunding firms, spanning 40 countries, and three financial modalities —participation (equity), lending, and donations— we revisit the theoretical issue of home bias in investments. Our results suggest the parallel existence of global bias, in investments with relatively low risk and spot pecuniary relationship between investor and beneficiary. We do reconfirm the existence of local bias, in investments with comparatively high risk and lasting pecuniary relationship between investor and beneficiary. This study simultaneously unveils both biases in different financing modalities in crowdfunding. From a theoretical perspective these findings contribute to theory regarding the geography of investments, by introducing the “global bias”, disentangling it from the “local bias” through context. For practitioners these findings have international policy implications. The emergence of a parallel global virtual capitalist system is fueled by the perceived opportunity behind the nascent “global bias”. The virtual system discussed here extends beyond the realm of traditional organization to make a real impact on the lives of millions of individuals across national borders.

Asset Allocation and Monetary Policy: Evidence from the Eurozone

The eurozone has a single short-term nominal interest rate, but monetary policy conditions measured by real short-term interest rates varied substantially across countries in the period 2003-2010. We use this cross-country variation in the (local) tightness of monetary policy to examine its influence on equity and money market flows. In line with a powerful risk-shifting channel, we find that fund investors in countries with decreased real interest rates shift their portfolio investment out of the money market and into the riskier equity market causing significant equity price inflation in countries where investment home bias is the strongest.

Bank relationships, business cycles, and financial crises

The importance of information asymmetries in the capital markets is commonly accepted as one of the main reasons for home bias in investment. The effects of such asymmetries may potentially be reduced through relationships between banks established through bank-to-bank lending. To analyze the dynamics of formation of such relationships during 1980–2009, I construct a global banking network of 7938 banking institutions from 141 countries. I find that recessions and banking crises tend to have negative effects on the formation of new connections and that these effects are not the same for all countries or all banks. I also find that the global financial crisis of 2008–09 had a large negative impact on the formation of new relationships in the global banking network, especially by large banks, which were previously immune to effects of banking crises and recessions.

Bank Relationships, Business Cycles, and Financial Crises

The importance of information asymmetries in the capital markets is commonly accepted as one of the main reasons for home bias in investment. We posit that effects of such asymmetries may be reduced through relationships between banks established through bank-to-bank lending and provide evidence to support this claim. To analyze dynamics of formation of such relationships during 1980-2009 time period, we construct a global banking network of 7938 banking institutions from 141 countries. We find that recessions and banking crises tend to have negative effects on the formation of new connections and that these effects are not the same for all countries or all banks. We also find that the global financial crisis of 2008-09 had a large negative impact on the formation of new relationships in the global banking network, especially by large banks that have been previously immune to effects of banking crises and recessions.

The introduction of the Euro and its effects on portfolio decisions

Examining investment behavior related to the Euro introduction, we address the relevance of different investment determinants. With the advent of the currency union two potential sources of portfolio reallocation can be distinguished: First, the diminishment of exchange rate risk and transaction costs within the EMU. Second, the increase of correlation of EMU returns so that diversification benefits decreased. We test for structural breaks in the holdings of German investors and estimate a market model to account for the two effects. A significant decrease in national and an increase in EMU and rest-of-the-world investments can be observed. Comparing the observed holdings with benchmark portfolios, we find that investment home bias has diminished since the Euro introduction.

The Introduction of the Euro and its Effects on Investment Decisions

In this paper we examine changes on investment decisions induced by the introduction of the Euro. There are two potential sources of portfolio reallocation. First, exchange rate risk diminished within the EMU region. Second, monetary policy has been bundled within one institution. We test for structural breaks in the portfolio holdings of German investors and estimate a market model in order to account for the two described effects. We observe a significant decrease in national and significant increase in intra-EMU as well as US investments. Therefore, the establishment of the EMU led to a decrease of investment home bias.

Why do countries combine the exemption system for the taxation of foreign profits with domestic double taxation relief?

Many European countries exempt foreign profits from domestic corporate taxation. At the shareholder level, however, all corporate profits are taxed, and double taxation relief is granted only for domestic corporate taxes. This paper attempts to rationalize this tax policy. In the presence of double taxation agreements which exempt foreign profits from domestic corporate taxation, countries may use shareholder taxes to tax these profits. The disadvantage of shareholder taxes is that they create incentives to sell domestic firms to foreigners. But double taxation relief for domestic profits may preserve domestic ownership. Our results imply that national dividend tax policies may be a factor contributing to the empirically observed home bias in investment.