Equity home bias puzzle

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The Equity home bias puzzle is the term given to describe the fact that individuals and institutions in most countries hold only modest amounts of foreign equity. This is puzzling since observed returns on national equity portfolios suggest substantial benefits from international diversification. The home bias in equities was first documented by French and Poterba (1991)[1] and Tesar and Werner (1995).[2]

Coval and Moskowitz (1999) showed that home bias is not limited to international portfolios, but that the preference for investing close to home also applies to portfolios of domestic stocks. Specifically, they showed that U.S. investment managers exhibit a strong preference for locally headquartered firms, particularly small, highly leveraged firms that produce nontradable goods.[3]

Maurice Obstfeld and Kenneth Rogoff identifies this as one of the six major puzzles in international macroeconomics.[4] The others are the Feldstein-Horioka puzzle, the home bias in trade puzzle, the consumption correlations puzzle, the purchasing power and exchange rate disconnect puzzle, and the Baxter-Stockman neutrality of exchange rate regime puzzle.

The home bias also creates some less obvious problems for investors, by diminishing the cost of capital for companies it limits the shareholders' ability to influence management by threatening to walk out. It partly explains why foreign investors tend to be better at monitoring firms they invest into.[5]

Attempts to resolve the puzzle[edit]

One hypothesis is that capital is internationally immobile across countries, yet this is hard to believe given the volume of international capital flows among countries.

Another hypothesis is that investors have superior access to information about local firms or economic conditions. But as van Nieuwerburgh and Veldkamp (2005)[6] point out, this seems to replace the assumption of capital immobility with the assumption of information immobility.

In some countries, like Belgium, holding stocks of foreign companies implies a double taxation on dividends, once in the country of the company and once in the country of the stockholder, while domestic stock dividends are taxed only once.


  1. ^ French, Kenneth; Poterba, James (1991). "Investor Diversification and International Equity Markets". American Economic Review 81 (2): 222–226. JSTOR 2006858. 
  2. ^ Tesar, Linda; Werner, Ingrid (1995). "Home Bias and High Turnover". Journal of International Money and Finance 14 (4): 467–492. doi:10.1016/0261-5606(95)00023-8. 
  3. ^ Coval, J. D.; Moskowitz, T. J. (1999). "Home Bias at Home: Local Equity Preference in Domestic Portfolios". Journal of Finance 54 (6): 2045–2074. doi:10.1111/0022-1082.00181. JSTOR 797987. 
  4. ^ Obsfeld, Maurice; Rogoff, Kenneth (2000). "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?". In Bernanke, Ben; Rogoff, Kenneth. NBER Macroeconomics Annual 2000 15. The MIT Press. pp. 339–390. ISBN 0-262-02503-5. 
  5. ^ Ferreira, M. A.; Matos, P. (2008). "The colors of investors' money: The role of institutional investors around the world". Journal of Financial Economics 88 (3): 499–533. doi:10.1016/j.jfineco.2007.07.003. 
  6. ^ Van Nieuwerburgh, Stijn; Veldkamp, Laura (July 2005). "Information Immobility and the Home Bias Puzzle". NYU Working Paper. FIN-04-026. SSRN 1294476.