Model Uncertainty, Financial Market Integration and the Home Bias Puzzle

Abstract

This paper investigates to what extent ongoing integration has eroded the equity home bias. To measure home bias, we compare observed foreign asset holdings of a set of 25 developed markets with optimal weights obtained from 5 benchmark models. Under the assumptions of the classical model in home bias studies, the International CAPM (I-CAPM), optimal portfolio weights are given by the relative world market capitalization shares. Four alternative models that allow for various degrees of mistrust in the I-CAPM and involve returns data in computing optimal portfolio weights, generally indicate a substantially lower yet still positive home bias. We observe a reduction in the home bias for many countries at the end of the 1990s and link the sharp decrease in the equity home bias to time-varying globalization and regional integration.JEL classification: F36, G11, G15

Bank Business Models and Performance During Crisis in Central and Eastern Europe

“…The successful implementation of different business models depend on a series of bank attributes and on the market environment like operating efficiency (Kwan and Eisenbeis, 1997), capital (Baele et al, 2007), securitization (Boot and Thakor, 2010), funding sources (Demirgüc-Kunt and Huizinga, 2010), corporate governance (Laeven and Levine, 2009), central bank liquidity (Altunbas et al, 2011), or, business cycles (Bolt et al, 2010).…”

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

“…The classical mean-variance approach could offer a fairly accurate measure of equity home bias as it takes into account asset returns which is crucial in portfolio choice theory. But, Merton (1980) and Baele et al (2007) pointed out the use of historical mean data as proxy for expected excess returns can be misleading as equity returns could be highly volatile.…”

“…By allowing for portfolio adjustments towards equities that offer higher returns at lower risks, financial integration enables equity home bias to decline. Accordingly, many studies in the field have explored the link between growing financial integration and declining equity home bias (Baele et al, 2007;Mondria and Wu, 2010;and Sørensen et al, 2007). The empirical findings suggest that greater financial market integration or openness leads to a decline equity home bias, although these findings are rather limited to the advanced economies in Europe, Japan, and the United States.…”

Bilateral Home Bias: New Perspective, New Findings

“…Descriptive statistics are provided for averaged bilateral home bias and deviations from optimality for three subsamples: (1) Baele et al (2007), for instance, the results suggest still a substantial I-CAPM home bias, corrected almost completely when data on asset returns is allowed to play a role in the investment decision. Bayesian and 'data-based' bilateral home bias are on average close to 0.…”

“…(1) (2) (3) (1) (2) (3) (1) (2) (3) 2001 -2003 2004 -2006 2007 -2009 2001 -2003 2004 -2006 2007 -2009 2001 -2003 2004 -2006 2007 -2009 Baele et al (2007), at the bilateral level, as well, deviations from optimality under the Bayesian perspective are dramatically decreased (by as much as 70%). The 'data-based' optimization framework is consistently furthest from the actual decisions of investors, with its large positive and negative positions in bilateral home bias resulting in the largest deviations from optimality.…”