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

Abstract

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.JEL Classification: G11, G15, M40, K00

Financial integration and the wealth effect of exchange rate fluctuations

“…In addition of the asset and liability positions, the BEA publishes a detailed breakdown of the changes in the value of U.S. assets and liabilities between the three drivers described above, as well as changes stemming from revisions in the data coverage and methodology (referred to as 'other valuation'changes). 1 A shortcoming is that a detailed breakdown is published only for the most recent year, and a revised breakdown for earlier years is available only for the aggregate NIIP. We can nevertheless estimate a revised detailed breakdown for assets and liabilities, with the details described in the Appendix.…”

Home bias persistence in foreign direct investments

“…Our empirical design allows us to measure whether home bias measured in terms of physical distance remains significant even when we control for those factors. The home bias literature in finance has attempted to explain the observed home bias effects mostly as a consequence of asymmetric information and transaction costs (Portes and Ray, 2005;Ahearne et al, 2004). We include a number of variables to see whether those explanations are to reduce the observed home country bias for foreign direct investments.…”

The determinants of current account imbalances in the euro area: a panel estimation approach

“…See, also, Briotti (2005), Bussiere et al (2005) and Debelle and Faruqee (1996). gained plausibility in the latest years of the sample when home bias in portfolio allocation had been on a declining trend (see, Ahearne et al, 2004). This understandably should be more so in the case of the euro area member states.…”