The Equity Home Bias Puzzle: A Survey

Equity home bias — the empirical phenomenon that investors’ port folios are concentrated in domestic equities to a much greater degree than justified by portfolio theory — has puzzled academics for decades. Financial theory predicts that, relative to what investors actually hold, further international diversification would reduce risk significantly without affecting expected return. In this monograph, we survey the literature on the equity home bias puzzle and provide an integrative empirical analysis of some proposed explanations for the puzzle. The standard measures of home and foreign bias are critically reviewed both on apriori grounds and on their ex-post relation to variables that should be related to bias. Empirically, we find that the equity home bias reflects a combination of factors, with information asym metries and economic openness (including the absence of costs such as taxes on international holdings) being the most important. We find that the bias is remarkably persistent and pervasive. It has fallen a little over time for Organisation for Economic Co-operation and Development (OECD) countries but still remains high, and has not diminished in non-OECD countries. We propose a new measure of home bias, which has some desirable properties compared with alternative measures that are commonly used. We conclude that the puzzle remains essentially unsolved, even thoug researchers have observed variables that are highly correlated with the extentof home bias. We emphasize that the puzzle is to identify quantitatively the mechanisms acting to offset the large potential gains from international diversification, and we indicate what are, in our opinion, the most promising areas for future research.