Information Immobility and Foreign Portfolio Investment

Abstract

We examine how residents of the United States allocate their stock portfolios internationally. We find that a large U. FDI establishes marginal differences in the endowments of information about different countries, which later translate into differences in stock portfolio holdings. We control for cross-country differences in capital controls, proximity along different dimensions, corporate governance, and economic and capital market development. Our results also hold for the G6 countries collectively. (JEL F21, F36, G11) How do investors allocate their stock portfolio internationally? The capital asset pricing model (CAPM) under purchasing power parity predicts that all investors hold the World Market Portfolio regardless of their nationality (Grauer, Litzenberger, and Stehle 1976). This prediction, however, is clearly at odds with the data (Karolyi and Stulz 2003), indicating that investors take into account factors other than the benefits of international diversification. Economists need alternative theories to describe how investors allocate their portfolios internationally.An important family of models asserts that cross-country differences in stock portfolio allocations arise because investors in different countries are endowed with different information sets (Gherig 1993;Brennan and Cao 1997;Kang and Stulz 1997). A long-standing conceptual difficulty with this argument is that information asymmetry would not be sustainable for long periWe are grateful to Geert Bekaert (the Editor) and two anonymous reviewers for excellent suggestions. For helpful discussions, we thank

U.S. International Equity Investment

“…we show that the Andrade and Chhaochharia [2010] result tying U.S. equity investment in a country to the level of U.S. foreign direct investment no longer holds, while the Desai and Dharmapala [2011] results showing a shift in portfolio allocations following the lowering of U.S. dividend taxes are somewhat weakened. Our objective is not to overturn the results of these papers-indeed, we estimate regressions that differ in important ways from the ones they implemented-but simply to show that conclusions from U.S. international investment papers are sensitive to the inclusion of a cross-listing variable (and a properly constructed dependent variable).…”

“…international investment (e.g., Didier, Rigobon, and Schmukler [2010], Andrade and Chhaochharia [2010], and Desai and Dharmapala [2011]) does not control for cross-listing, implicitly treating the cross-listing effect as a sample selection issue. Because we establish that causation runs from cross-listing to U.S. investment, it is important to ascertain whether failure to include the cross-listing effect could alter inferences in the current literature.…”

“…In the final section of the paper, we reproduce regressions from two recent country-level U.S. equity investment papers, Andrade and Chhaochharia [2010] and Desai and Dharmapala [2011]. We add a cross-listing variable to these regressions, instrumenting for potential endogeneity in the crosslisting decision, and use a dependent variable that is both adjusted for closely held shares (following Dahlquist, Pinkowitz, Stulz, and Williamson [2003] and Kho, Stulz, and Warnock [2009]) and free of a size bias (Bekaert, Siegel and Wang [2012]).…”

Equity home bias, financial integration, and regulatory reforms: implications for emerging Asia

“…These risks include domestic inflation, human capital, and foreign returns of domestic firms with overseas operations (Baxter and Jermann, 1997;and Lewis, 1999). The other leading explanation focuses on the effects of transaction and information costs on investors' international portfolio positions (Ahearne et al, 2004;Andrade and Chhaochharia, 2010;Cai and Warnock, 2004;Chan et al, 2005;Van Nieuwerburgh and Veldkamp, 2009;and Warnock, 2002). Ahearne et al (2004) suggest that transaction costs related to international investments may not be huge, but a proxy for information cost is a significant determinant for a country's weight in US investors' portfolios.…”

“…Van Nieuwerburgh and Veldkamp (2009) present a model where investors' learning process contributes to the lock-in effect of their investment in local assets. Applying their model, Andrade and Chhaochharia (2010) show that the endowments of information about a new country by foreign direct investment might translate into an increase in their portfolio holdings in the same country.…”