International portfolio diversification is better than you think

Using aggregate data on bilateral cross-border equity holdings, we investigate whether investors correctly hedge their over-exposure to domestic risk (the well-known equity home bias) by investing in foreign stock markets that have low correlation with their home stock market. To deal with the endogeneity of stock return correlations, we instrument current correlations with past correlations. Controlling for many determinants of international portfolios, we find that, all else equal, investors do tilt their foreign holdings towards countries, which offer better diversification opportunities. The diversification motive that we uncover is stronger for source countries exhibiting a higher level of home bias.     

Is local bias a cross-border phenomenon? Evidence from individual investors’ international asset allocation

Extant literature consistently documents that investors tilt their domestic equity portfolios towards regionally close stocks (local bias). We hypothesize that individual investors’ local bias is not limited to the domestic sphere but instead also determines their international investment decisions. Our results confirm the presence of a cross-border local bias. Specifically, we show (i) that the stockholdings of individual investors living within regional proximity to a foreign country display a significantly lower foreign investment bias towards investment opportunities in that country and (ii) that this drop in foreign investment bias levels is disproportionately driven by investments in regionally close neighbor-country companies. The impact of cross-border local bias on investors’ bilateral foreign equity investments is economically significant and holds even after controlling for previously identified explanations of international asset allocation.     

Uncovered Equity Parity and rebalancing in international portfolios

Portfolio rebalancing is a key driver of the Uncovered Equity Parity (UEP) condition. According to UEP, when foreign equity holdings outperform domestic holdings, domestic investors are exposed to higher exchange rate exposure and hence repatriate some of the foreign equity to decrease their exchange rate risk. By doing so, foreign currency is sold, leading to foreign currency depreciation. We examine the relationship between U.S. investors' portfolio reallocations and returns and find some evidence consistent with UEP: Portfolio shifts are related to past returns in the underlying equity markets. But we argue that a motive other than reducing currency risk exposure is likely behind this rebalancing. In particular, U.S. investors rebalance away from equity markets that recently performed well and move into equity markets just prior to relatively strong performance, suggesting tactical reallocations to increase returns rather than reduce risk.     

Immigration and equity home bias

Why do investors hold such large positions in domestic equity when there are gains to be made from international diversification? This equity home bias puzzle has received considerable attention in the literature, with asymmetric information on domestic and foreign assets (whether by individual choice or by market imperfection) emerging as the most plausible explanation. What happens when we consider a subset of investors whose information sets are closer to investors in foreign countries? I assess the relationship between immigration and equity home bias and find that inward migration is positively correlated with increased foreign equity positions and reduced home bias. Looking across income groups, outward migration reduces home bias for relatively rich countries, but may actually increase home bias when migration occurs to or from a developing country. These results suggest that immigration generates a positive externality of increased information flows for developed countries, but not for developing nations. The effects of immigration on investment are strongest within the Euro-Zone, suggesting that this positive externality of immigration is largest when barriers to portfolio diversification (such as currency risk) are lowest.     

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

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.     

Country-specific equity market characteristics and foreign equity portfolio allocation

Do country-specific equity market characteristics explain variations in foreign equity portfolio allocation? We study this question using comprehensive foreign equity portfolio holdings data and different measures of country-specific equity market factors for 36 host countries. Employing panel data econometric estimations, our investigation shows that foreign investors prefer to invest more in larger and highly visible developed markets which are more liquid, exhibit a higher degree of market efficiency and have lower trading costs. The findings imply that by improving the preconditions necessary for well-functioning capital markets, policymakers should be able to attract higher levels of foreign equity portfolio investments.     

Is gold a safe haven against equity market investment in emerging and developing countries?

The hedge and safe haven properties of gold in advanced economies’ financial markets are well documented in the literature. Studies of how this issue relates to emerging markets and developing countries are, however, very limited. This paper aims to fill this gap by empirically analyzing the hedge and safe haven properties of gold against equity market investment for a large group of emerging and developing countries from the perspective of both domestic and foreign investors. We also check whether our findings differ in the post-global crisis period. Our results show that for domestic investors, gold is both a hedge and a safe haven in most of these countries. This result also holds in the post-2008 crisis period. In addition, when falls in equity markets become more severe, gold acts as a safe haven in a larger set of countries for both domestic and foreign investors.     

Do locals know better? A comparison of the performance of local and foreign institutional investors

We compare the performance of local versus foreign institutional investors using a comprehensive data set of equity holdings in 32 countries during the 2000–2010 period. We find that foreign institutions perform as well as local institutions on average, but only domestic institutions show a trading pattern consistent with an information advantage. Our results suggest a smart-money effect of local institutions in countries subject to higher information asymmetry, non-English speaking countries, countries with less efficient stock markets, with poor investor protection, or high levels of corruption. The local advantage is more pronounced in periods of market turmoil and in illiquid stocks.     

Equity Home‐Bias: A Suboptimal Choice for UK investors?

In spite of the popularity of international portfolio diversification theory, extant empirical literature shows that investors prefer domestic assets and as a result, many studies argue that investors' portfolios are largely suboptimal. This paper examines whether British investors need to diversify their portfolios internationally to gain performance benefits from international markets or can they obtain these benefits by mimicking the portfolios with domestically traded assets. The results confirm that it is possible to mimic the performance of foreign equity with domestic equity. Indeed, the pay‐offs from homemade portfolios outperform those from international portfolios regardless of the periodic variation in the overall performance of the UK market vis‐à‐vis foreign markets. The superiority of homemade portfolio is more prominent in recent years and is enhanced by the increased internationalisation of developed capital markets. Therefore, investors' home bias is not suboptimal.     

Foreign exposure through domestic equities

We show that US investors obtain substantial foreign exposure through their holdings of domestic equities. Domestic multinationals, in particular, provide significant foreign exposure. We also find that, although the average US investor is less tilted toward domestic multinationals, institutional investors do overweight domestic firms that are more internationally oriented. ‘Indirect’ foreign holdings through domestic multinationals are shown to be substantial; combining them with reported data on international positions almost doubles US investors’ total ‘foreign’ holdings. Our findings indicate that the home bias is not as severe as assessments based on reported international investment statistics suggest.     

Price Comovement and Institutional Performance Following Large Market Movements

This paper investigates the price comovement of stocks actively traded by institutions and the investment performance of foreign and domestic institutional investors in Taiwan's stock markets during periods of large market movements. Stocks of small size, high share turnover, and high return volatility tend to move together with the market when markets rise sharply. In short-term holdings, foreign investors and domestic mutual funds can outperform the market by trading small-size, high-turnover, and high-volatility stocks.     

Foreign shareholders,relative foreign policy uncertainty and corporate cash holdings

Studies have shown that foreign investors hedge risks stemming from economic and political uncertainty in the home country through outward investment. This paper studies how foreign investors' home country risk affects their overseas investment and the host country firms' corporate cash holdings. We find that relative foreign EPU, defined as the difference between foreign investors' home country EPU and the host country of investment EPU, negatively impacts the host country firms' cash holdings through their influences on managerial decision-making. This negative relationship arises from firms' precautionary and transaction motives as foreign investors perceive lower corporate risk and better investment opportunities in the host country firms. Good corporate governance is also instrumental in yielding this negative relationship. The reduction in cash holdings due to high relative foreign EPU is more pronounced if foreign investors' home country legal environment is weaker, the two countries are further apart, and there is little trade partnership between them.     

Foreign equity investment restrictions, capital flight, and shareholder wealth maximization: theory and evidence

This article provides a theory of foreign equity investmentrestrictions. We consider a model where the demand functionfor domestic shares differs between domestic and foreign investorsbecause of deadweight costs in holding domestic and foreignsecurities that depend on the country of residence of investors.We show that domestic entrepreneurs maximize firm value by discriminatingbetween domestic and foreign investors. The model implies thatcountries benefiting from capital flight have binding ownershiprestrictions such that foreign investors pay a higher pricefor shares than domestic investors. The empirical implicationsof this theory are supported by evidence from Switzerland.     

Stock Returns and Volatility under Market Segmentation: The Case of Chinese A and B Shares

In most countries where firms list separate shares for trading by foreign and domestic investors, the prices of the foreign shares tend to be higher. In China, the reverse tends to be true. In this paper, we would like to focus on the information content in lagged premiums of Chinese A over B traded shares. The lagged premiums are found to have certain predictive power over the future returns and volatility of both A and B shares, with some interesting patterns. Specifically, an increase in the premium ratio of A shares will be followed by a rise in the return of A shares and a fall in the return of B shares. It is found that both of the investors in Chinese A- and B-share markets reveal positive feedback trading behavior. Moreover, the liquidity and information availability will affect the magnitude of such behavior especially in B-share markets. By using multivariate GARCH model, it is also demonstrated that the unexpected changes in the premium ratio of A-share price over B-share price contribute to the return volatility of both A shares and B shares. These patterns may provide foundations for the development of pricing models for equity shares under market segmentation.     

The Effects of Firm-Level Investability Sizes on Foreign Ownership in Indonesian Public Firms

This study investigates whether foreign investors investing in Indonesian public firms are basing their holdings on investability size, given other firms’ attributes such as dividend, liquidity, leverage, profitability, firm size, growth opportunity, and inter-industry factors. The analysis on this study is conducted using multiple regression analysis on the data that consists of free-float foreign ownership share in non-financial companies listed in the Indonesia Stock Exchange over the period 2014–2015. It is found that foreigners prefer holding stocks in larger investability and firm sizes, higher dividends, and the consumer goods industry sector. Aside from well-established firm-specific determinants of the degree of foreign ownerships in the literature that foreigner invest more in shares of large firms in a particular industry sector with higher dividends, this study also provides evidence that foreign investors require widely available shares for their investment in a foreign country. Understanding the determinants of foreign investors’ preferences may provide valuable insights for policy makers and Indonesian firms in attempts to attract foreign investment to the stock market.     

Home Bias in Emerging Bond and Stock Markets

In this paper, we empirically examine sizes and sources of home bias in both bond and equity markets for twenty emerging countries and twenty-two developed countries over the 2001-11 sample period. The average size of home bias in both bond and stock markets is found to be much larger in emerging countries than in developed countries. Using the explanatory variables in two categories of economic development and market performance, we employ dynamic panel data regression models to analyze major sources of home bias. The main results are the following: First, market performance factors generally affect home bias more strongly than do economic development factors. Second, market factors including market return, volatility, and liquidity support various hypotheses under informational asymmetries, such as return chasing, risk aversion, and flight to quality. Third, among macroeconomic factors, it is shown that real gross domestic product growth has negative effects and country leverage has positive effects on a specific home bias, backing up the size-bias and the flight-to-quality hypotheses, respectively. Finally, and perhaps most important in this paper, the effect of bond market performance on equity home bias is found to be significantly stronger than the effect of equity market performance on bond home bias from the market interaction model estimation, suggesting that a policy design needs to begin with increasing bond market efficiency to reduce equity market home bias.     

The determinants of domestic and foreign bond bias

This paper studies the determinants of the domestic and the foreign bond biases and their evolution over time using aggregate bond allocation data from CPIS. Our results show that the home bias is prevalent across all countries, despite the decreasing of the domestic bias in most countries in the 1997–2009 period. We find that the domestic bond bias is lower in countries with higher economic development, higher restrictions on foreign capital transactions, more developed bond markets, higher familiarity, and higher efficiency of the judicial system. When investing overseas, investors also prefer to allocate their investments in countries with higher economic development, lower restrictions on capital flows, more developed bond markets, stronger judicial systems, and higher past returns. Additionally, we find that familiarity (i.e. geographic proximity, common language, and bilateral trade) is a major determinant to decrease the foreign bias. Finally, there is no evidence that investors’ bond allocations are explained by diversification opportunities as proxied by bond markets correlations.     

Forms of Foreign Investment Liberalization and Risk in Emerging Stock Markets

I examine the effect of different forms of foreign investment liberalization on risk in emerging equity markets, including international cross-listings and closed-end country funds, and in the domestic equity market as foreign investment restrictions are eliminated. I find that in Latin American markets volatility declines significantly with different forms of foreign investment liberalization, and in Asian markets volatility does not increase significantly. Volatility is driven by domestic factors in South America, but the transmission of volatility from the United States to Mexico increases after liberalization. The market risk exposure increases in Argentina after liberalization, in Chile with an index of American Depositary Receipts, and in Thailand with greater foreign ownership, reducing the diversification benefits of these markets.     

Foreign market portfolio concentration and performance

Using security holdings of 49,857 foreign investors on the Oslo Stock Exchange (OSE), I test whether concentrated investment strategies in international markets result in excess risk-adjusted returns. I find that investors with higher learning capacity increase returns, while investors with lower learning capacity decrease returns from the portfolio concentration. I measure learning capacity as institutional classification, geographical proximity to Norway, and cultural closeness to Norwegian investors (as based on the Hofstede cultural closeness measures). I conclude, consistent with the information advantage theory, that concentrated investment strategies in foreign markets can be optimal (disastrous) for investors with higher (lower) learning capacity.     

International investment patterns: Evidence using a new dataset

This paper examines the bilateral, source and host factors driving portfolio equity investment across a set of countries using International Monetary Fund's new dataset on international equity holdings at the end of 1997, 2001 and 2002.The paper finds that the bilateral equity investment is strongly correlated with the underlying patterns of trade in goods and services. The information asymmetries and cultural-institutional proximity are important for bilateral equity investment. The size of domestic stock market is the key correlate of aggregate foreign portfolio equity asset and liability holdings. The scale of aggregate foreign equity asset holdings is larger for countries having high income per capita.