Investors hold a substantially larger proportion of their wealth portfolios in domestic assets than standard portfolio theory would suggest, a phenomenon called "equity home bias." In the absence of this bias, investors would optimally diversify domestic output risk using foreign equities. Therefore, consumption growth rates would tend to co-move across countries even when output growth rates do not. Empirically, however, consumption growth rates tend to have a lower correlation across countries than do output growth rates, a phenomenon I call "consumption home bias." In this paper, I discuss these two biases and their potential relationship as suggested by the literature.

Trying to Explain Home Bias in Equities and Consumption

https://www.nber.org/system/files/working_papers/w7336/w7336.pdf

The determinants of cross-border equity flows

We examine how mutual funds from 26 developed and developing countries allocate their investment between domestic and foreign equity markets and what factors determine their asset allocations worldwide. We find robust evidence that these funds, in aggregate, allocate a disproportionately larger fraction of investment to domestic stocks. Results indicate that the stock market development and familiarity variables have significant, but asymmetric, effects on the domestic bias (domestic investors overweighting the local markets) and foreign bias (foreign investors under or overweighting the overseas markets), and that economic development, capital controls, and withholding tax variables have significant effects only on the foreign bias.

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What Determines the Domestic Bias and Foreign Bias? Evidence from Mutual Fund Equity Allocations Worldwide

We apply a new approach to a new panel data set on bilateral gross cross-border equity flows between 14 countries, 1989-96. The remarkably good results have strong implications for theories of asset trade. We find that the geography of information heavily determines the pattern of international transactions. Our model integrates elements of the finance literature on portfolio composition and the international macroeconomics and asset trade literature. Gross asset flows depend on market size in both source and destination country as well as trading costs, in which both information and the transaction technology play a role. The resulting augmented gravity' equation has equity market capitalisation representing market size and distance proxying some informational asymmetries, as well as a variable representing openness of each economy. But other variables explicitly represent information transmission (telephone call traffic and multinational bank branches), an information asymmetry between domestic and foreign investors (degree of insider trading), and the efficiency of transactions ( financial market sophistication'). This equation accounts for almost 70% of the variance of the transaction flows. Dummy variables (adjacency, language, currency or trade bloc, and a major financial centre' effect) do not improve the results, nor does a variable representing destination country stock market returns. The key role of informational asymmetries is confirmed. Our information transmission variables also substantially improve standard gravity equations for trade in goods.

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The Determinants of Cross-Border Equity Flows

Despite the dramatic reduction in explicit barriers to international investment activity over the last 60 years, the impact of financial globalization has been surprisingly limited. I argue that country attributes are still critical to financial decision-making because of “twin agency problems” that arise because rulers of sovereign states and corporate insiders pursue their own interests at the expense of outside investors. When these twin agency problems are significant, diffuse ownership is inefficient and corporate insiders must co-invest with other investors, retaining substantial equity. The resulting ownership concentration limits economic growth, financial development, and the ability of a country to take advantage of financial globalization.

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The Limits of Financial Globalization

https://www.federalreserve.gov/pubs/ifdp/2000/691/ifdp691r.pdf

Information costs and home bias: an analysis of US holdings of foreign equities

We aim to provide insight into the observed equity home bias phenomenon by analyzing the determinants of U.S. holdings of equities across a wide range of countries. In particular, we explore the role of information costs in determining the country distribution of U.S. investors' equity holdings using a comprehensive new data set on U.S. ownership of foreign stocks. We find that U.S. holdings of a country's equities are positively related to the share of that country's stock market that is listed on U.S. exchanges, even after controlling for capital controls, trade links, transaction costs, and historical risk-adjusted returns. We attribute this finding to the fact that foreign firms that list on U.S. exchanges are obliged to provide standardized, credible financial information, thereby reducing information costs incurred by U.S. investors. This obligation stems from U.S. investor protection regulations, which include stringent disclosure requirements, reconciliation of financial statements to U.S. standards, and an investor-friendly regulatory environment. Our results support the hypothesis that information costs are an important source of home bias: Foreign countries whose firms do not alleviate information costs by listing on a U.S. exchange are more severely underweighted in U.S. equity portfolios.

Information costs and home bias: an analysis of U.S. holdings of foreign equities

The tremendous growth in cross-border securities investment in recent years has called attention to the systems used by the United States and other countries to measure international securities flows and holdings. Ideally, the data gathered by the United States could tell us the extent to which foreign investors hold U.S. securities, the types of securities held, and the countries in which the securities are held, for example, and could identify trends in investment. This article looks at how well the data shed light on these topics. Special attention is given to the system's design and the implications of the design for data analysis. Also discussed are anticipated changes to the system and international efforts to improve data collection systems worldwide.

/pdf/the-u-s-system-for-measuring-cross-border-investment-in-3lqj2nbodr.pdf

The U.S. System for Measuring Cross-Border Investment in Securities: A Primer with a Discussion of Recent Developments

In recent years, foreign holdings of U.S. securities have grown markedly. During 2005, reported foreign holdings increased nearly $1 trillion for the second consecutive year, bringing the estimated total to about $7.3 trillion, or roughly 16 percent of all U.S. longterm securities outstanding at year-end. These large numbers are understandably attracting a great deal of attention, as external deficits are a subject of growing concern in today’s global economy. In this article, we present current data on U.S. cross-border securities holdings and transactions and describe the system that collects the data. We discuss how to make the best use of the information available by avoiding common misinterpretations of the data and by adjusting the published figures to improve their accuracy and comprehensiveness. We also discuss how to construct monthly estimates of crossborder securities holdings by country, combining monthly transactions data with less frequently reported positions data. Besides providing moretimely measures of holdings of securities, these estimates incorporate a number of adjustments that improve our overall picture of cross-border portfolio positions. Finally, to improve our ability to correctly attribute U.S. liabilities to foreign holders, we compare our estimates of foreign holdings of U.S. securities with estimates obtained from asset surveys conducted by other countries.

/pdf/understanding-u-s-cross-border-securities-data-2u68vj9ccx.pdf

Understanding U.S. Cross-Border Securities Data

The tremendous growth in cross-border securities investment in recent years has called attention to the systems used by the United States and other countries to measure international securities flows and holdings. Ideally, the data gathered by the United States could tell us the extent to which foreign investors hold U.S. securities, the types of securities held, and the countries in which the securities are held, for example, and could identify trends in investment. This article looks at how well the data shed light on these topics. Special attention is given to the system's design and the implications of the design for data analysis. Also discussed are anticipated changes to the system and international efforts to improve data collection systems worldwide. Finally, in an appendix we illustrate the technique for estimating holdings using capital flows data.

/pdf/the-u-s-system-for-measuring-cross-border-investment-in-422z2scejg.pdf

William L. Griever

Papers

Information costs and home bias: an analysis of US holdings of foreign equities

Information costs and home bias: an analysis of U.S. holdings of foreign equities

The U.S. System for Measuring Cross-Border Investment in Securities: A Primer with a Discussion of Recent Developments

Understanding U.S. Cross-Border Securities Data

The U.S. System for Measuring Cross-Border Investment in Securities: A Primer with a Discussion of Recent Developments