Home Bias in Emerging Bond and Stock Markets

Abstract

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.

Foreign and Domestic Investment in Global Bond Markets

“…We first compare our statistics with Kim et al (2014) since we use the same data sources. In general, the home bias measures in our sample are very comparable to those in Kim et al (2014). Panel A shows that in terms of mean foreign bias, most developed bond markets are overweighed by foreign investors with a foreign bias higher than 0, while emerging bond markets are underweighed by foreign investors.…”

“…In the literature on investment behavior in global bond markets, there is a group of studies that examine how risk-return factors drive investment bias. Evidence on domestic bias includes Fidora, Fratzscher, and Thimann (2007) and Kim et al (2014). Fidora, Fratzscher, and Thimann (2007) examine the role of real exchange rate volatility on global bond and equity portfolio decisions.…”

“…They show that real exchange rate volatility significantly explains home bias in global financial markets and that reduced real exchange rate volatility helps decrease home bias, especially for bond portfolios. Kim et al (2014) investigate foreign investment in global bond and stock markets, and find that market performance has a more pronounced impact than macroeconomic factors on home biases in both bond and equity markets. Other researchers look at foreign biases.…”

“…(ii) What factors drive discrepancies in the portfolio decisions of foreign versus domestic investors? By addressing the above questions, we extend Fidora, Fratzscher, and Thimann (2007) and Kim et al (2014) with novel evidence on how foreign investors react to riskreturn attributes in global bond markets. We also add to Burger and Warnock (2007); Burger, Warnock, and Warnock (2012);and Horioka, Terada-Hagiwara, and Nomoto (2016) a new angle that compares the investment behaviour of foreign versus domestic investors in global bond markets.…”

“…Existing evidence on investment decisions in bond markets show that bond market risk and return attributes significantly influence home bias (Fidora, Fratzscher, and Thimann2007;Kim et al 2014) and foreign bias (Burger and Warnock 2007;Burger, Warnock, and Warnock 2012;Horioka,Terada-Hagiwara, and Nomoto 2016) in bond markets. In this study, we contribute to the literature by assessing and comparing foreign and domestic investor preferences toward risk-return profiles in global bond markets.…”