The world price of home bias

Theoretical arguments suggest that as the degree of a country's home bias increases, the global risk sharing between domestic and foreign investors will reduce and thereby increase the country's cost of capital. Consistent with this prediction, we find international differences in the cost of capital to be strongly and positively related to varying degrees of home bias for 38 markets. This finding is robust to different cost of capital proxies, different control variables, alternative home-bias measures, international tradability of stocks, and alternative specifications. Therefore, the overall evidence implies that countries may enjoy a significantly lower cost of capital by reducing the extent of their home bias and hence, increasing global risk sharing.