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The International Diversification Puzzle: Home Bias in Countries’ Investment Portfolios

Kleinert, Helena

Studienreihe der Stiftung Kreditwirtschaft an der Universität Hohenheim, Vol. 53

(2016)

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Abstract

This work analyzes determinants of portfolio decisions in the context of cross-country diversification, which cause significant overweighting of the respective domestic market. By amending traditional determinants with cross-cultural variables, this work enhances current insights on the home bias phenomena.

In addition, the study sheds light on the capital market anomaly in the context of consumption risk and documents that the increasing importance of foreign positions in international investment portfolios improves international consumption risk sharing among economies.

Table of Contents

Section Title Page Action Price
Preface 5
Table of Contents 6
List of Figures 8
List of Tables 9
Abbreviations 10
Country Abbreviations 12
Variables and Indices 13
Introduction 17
A. Home Bias in International Investment Portfolios – A Literature Review 21
1. Introduction 21
2. International Diversification and Home Bias in Portfolio Allocation 22
2.1 Gains from International Diversification 22
2.2 Empirical Evidence of the Home Bias 25
2.3 Measuring Home Bias in international portfolio allocation 27
3. Calculation optimal portfolio weights 29
3.1 Classical Mean-Variance Portfolio Model 29
3.2 International Capital Asset Pricing Model 30
3.3 Bayesian Portfolio Weights 31
3.4 Gravity Model Approach 33
3.5 Discussion of the optimization frameworks 33
4. Potential Explanations for the Home Bias 35
4.1 Institutional Perspective 35
4.1.1 Overview 35
4.1.2 Transaction Costs 36
4.1.3 Hedging of domestic risk 36
4.1.4 Information asymmetry 38
4.1.5 Corporate Governance 42
4.2 Behavioral Perspective 43
4.2.1 Overview 43
4.2.2 Relative Optimism 44
4.2.3 Overconfidence and investor’s competence 45
4.2.4 Herding 46
4.2.5 Familiarity 46
4.3 Discussion of the explanation attempts 47
5. Conclusion 48
B. Cultural Influences on Domestic and Foreign Bias in International Asset Allocation 51
1. Introduction 51
2. Data and Placement in Literature 53
2.1 Data 53
2.2 Placement in Literature 54
3. Calculation of the dependent variables 56
4. Explanatory Variables and Regression Framework 59
4.1 Explanatory Variables 59
4.2 Regression Framework 67
5. Empirical Results 71
5.1 Results for the Domestic Bias 71
5.2 Results for the Foreign Bias 76
5.3 Robustness Test 81
5.3.1 Additional Country Controls 81
5.3.2 Income Analysis 83
5.3.3 Geographic Analysis 91
5.3.4 Financial Crisis 92
6. Conclusion 96
C. Is increasing Financial Integration related to improved International Risk Sharing? 97
1. Introduction 97
2. Data 99
3. Theoretical Background and Placement and Literature 101
3.1 International Portfolio Holdings and the Equity Home Bias 101
3.2 International Risk Sharing 104
3.2.1 Theory 104
3.2.2 Measuring International Risk Sharing and empirical evidence 107
4. Patterns of Risk Sharing and International Asset Positions 110
4.1 Channels of Risk Sharing 110
4.2 The Increase in International Risk Sharing and the growth in Gross International Asset Positions 113
4.2.1 International financial integration proxied by the Equity Home Bias 113
4.2.2 International Financial Integration proxied by Foreign Equity Holdings to GDP 115
5. Conclusion 118
Summary 121
References 124