Home Bias in Equity Portfolios: Theory and Evidence for Developed Markets

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1 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Hom Bias in Equity Potfoios: Thoy and Eidnc fo Dopd Makts ESSEC Tunis, Unisity of Tunis, Tunisia Dhouha Hadidan Chkioua & Ezzddin Abaoub 2 2 FESG Nabu, Unisity of Cathag, Tunisa Cospondnc: Dhouha Hadidan Chkioua, Schoo ESSEC Tunis, Unisity of Tunis, 4 Ru Abou Zakaia E Hafsi, 089 Montfuy, Tunisia. T: E-mai: dhouhachk@yahoo.f Rcid: Fbuay 4, 202 Accptd: Api, 202 Pubishd: Jun, 202 doi:0.5539/ijf.4n6p6 URL: Abstact Equity hom bias is on of th most impotant puzzs in intnationa financ. This pap tis to masu th hom bias quity basd on Wanock W find stong idnc fo th phnomna in nin dopd financia makts duing W thn tst th Intnationa Capita Asst Picing Mod ICAPM of Ad and Dumas 983 in od to pain th hom bias by infation hdging. W aso tst ICAPM of Coën 200 which incuds infation and human capita. Ou findings suggst that ths two mods a jctd. Th ack of intnationa disification in quity potfoios is sti a puzz in intnationa financ. Kywods: intnationa potfoio disification, hom bias quity, goba financia makts, financia intgation. Intoduction At th nationa, th potfoio thoy of Makowitz 959 showd that th incusion of sighty coatd assts in a potfoio ducs significanty th isk. At th intnationa, th bnfits of intnationa disification w highightd sinc pion woks of Gub 968, Ly and Sanat 970, Sonik 974, tc. Ths bnfits a aottd to wak coation btwn financia makts. With th financia gobaisation, on woud pct that instos disify intnationay thi potfoios and tak adantag of intnationa disification. How, instos psnt a stong pfnc fo nationa assts. This bhaio cad hom bias is not th fact of hazad, but has sa panations in th financia itatu. Th most common causs a asymmtic infomation, infation isk, non tadd assts, tansaction costs and sgmntation of financia makts. In this pap, w wi ty in th fist stp, to masu th hom bias in insto potfoios of nin dopd countis duing th piod In th scond stp, w us th mod of Ad and Dumas 983, to tst whth th hdging infation coud pain th hom bias. In th thid stp, w tst th Intnationa CAPM dopd by Coën 200, to chck if human capita isk gnats th obsd hom bias. 2. Litatu Riw Th mpiica studis on intnationa potfoio disification stipuat that th majoity of quitis a hd by domstic instos. Fnch and Potba 99 showd that th popotions of domstic quitis in th fi ag financia makts w spctiy of 92.2% fo Unitd Stats, 95.7% fo Japan, 92% fo Unitd Kingdom, 79% fo Gmany and 89.4% fo Fanc. Lwis 998 is basd on a man-aianc mod to pain th ation btwn aags and aiancs in intnationa financia makts. Using a wod psntd by two makts, th US makt and ind EAFE Not, th optima potfoio indicats that, fo a ow of isk asion, Amican insto shoud choos a potfoio with 39.75% of foign scuitis. This wighting woud pass to 39.45% fo high s of isk asion. Ths suts suggst th psnc of a stong hom bias fo any of isk toanc. Hay 993 amind th tuns of 20 mging makts and showd that th standad mods basd on intgatd capita makts don t pain th quity tuns in ths countis; H concudd that mods basd on makt sgmntation a mo suitab than mods basd on makt intgation. 6 ISSN 96-97X E-ISSN

2 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Coop and Kapanis 994 poposd a mod of intnationa potfoio choic which intgats th diations fom Puchasing Pow Paity and dadwight costs. Thy showd that th bais to intnationa instmnt don t constitut a cucia facto imiting th attaction of intnationa disification. Vassaou 2000 tstd th mods of Gau, Litznbg and Sth 976, Sonik 974 Scu 980 and Ad and Dumas 983, H potd that, th hom bias cannot b causd by th dsi of instos to hdg against pic unctainty. Kang and Stuz 997 instigatd stock ownship in Japans fims by non Japans instos fom Januay 975 to Dcmb 99, thy documntd that th pfnc of domstic stocks suts fom an infomation asymmty btwn domstic and foign instos. Cho, Kho and Stuz 200 amind th qustion of whth domstic instos ha btt infomation than foign instos. Using Koan data fom Dcmb 996 to Nomb 998, th authos found a diffnc in th pfomanc of domstic and foign instos. Baah and Aboua 2006 poposd a capita asst picing mod in psnc of asymmty infomation and tansaction costs. Th tst suts o th piod , showd that th infomation costs w ngatiy coatd with th pctd tun. Baon and Ni 2008 studid th impact of asymmtic infomation on quity hom bias in intnationa financ. By doping a ationa anticipation mod wh infomation acquisition is ndognous, th authos found a ation btwn th potfoio siz, th infomation cost and th dg of hom bias in ach county. Amadi and Bgin 2008 constuctd a potfoio aocation mod with aious configuations of th tading costs. Thy showd that tuno ats tnd to b high among foign compad to domstic hodings. In th sam way, thy dmonstatd that th psnc of agnts that confont diffnt tading cost poducd a notab hom bias. Mondia and Wu 200 dopd a mod wh instos fac an infomation constaint and ha a oca infomationa adantag. Th suts indicat that th hom bias mains impotant in th ong un bcaus of th intaction btwn infomation and potfoio choics. Th mpiica tsts suppot th pincipa pdictions of th mod that bias incass with infomation capacity and dcass with financia intgation. Bat and Jmann 997 anayzd th mpiica impications of non tadd assts on potfoio choic fo an US insto insting in fou countis duing th piod ; thy found that th hom bias wosns with human capita isk. Coën 200 dopd an Intnationa CAPM with human capita and dadwight costs. Th mpiica tsts suggstd that th non tadd assts don t gi an pication to th hom bias puzz. 3. Thotica Mods 3. Th Mod of Ad and Dumas 983: Th Infation Hdging To pain th hom bias puzz by th moti of infation hdging, w us th mod of Ad and Dumas 983, which supposs that in a wod of L+ countis and cuncis and N isky assts, th nomina tuns R i, masud in tms of L+ th cuncy Not 2, foow a stationay pocss of Itô : Ri idt idzi, i :,..., N i : Th instantanous pctd nomina tun of scuity i; i : Th instantanous isk of scuity i; dz i : Th incmnt to a standad Gauss Win pocss. Th mod aso supposs that th a L+ insto typs, th infation at of an insto pssd in cuncy foows a stationay pocss: p dt dz, :,..., L 2 : Th pctd instantanous infation at of an insto ; : Th standad diation of instantanous infation at; dz : Th incmnt to a standad Gauss Win pocss. Pubishd by Canadian Cnt of Scinc and Education 7

3 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Basing on ths two assumptions, Ad and Dumas 983 showd that ach insto in th wod hods a potfoio composd of two funds: th fist is a common potfoio to a instos and th scond is a potfoio of hdging against infation. Th cto of th popotions instd in ach isky scuity is: 3 : N cto of th popotions instd in ach isky scuity fo insto; : Risk toanc of insto th s of isk asion; : N N instantanous coaianc mati of nomina tuns on aious assts; : Th instantanous at of tun of iskss asst; : N Vcto of coaiancs of N isky asst tuns with insto s infation at ; : N cto of ons. To stimat th quation 3, w wi foow th mthodoogy of Coop and Kapanis 994, w thus suppos that th isk toanc is idntica fo a instos, pctd tuns can b iminatd with th agggation condition: 4 : Th popotion of th county s wath in th wod wath fo L county; : a cto whos th componnt psnts th popotion of county s makt capitaization in th wodwid makt, fo,..., L 0 fo > L. Using ations 3 and 4, w can wit Not 3: / 5 This quation indicats that th diations of insto potfoio fom th wodwid potfoio a popotiona to a cto of gssion cofficints. Coop and Kapanis 994 suggst that th mutip gssion of th aiab p p, masuing th diations of insto infation at fom wod infation on th cto of nomina asst tuns, psnt cofficints qua to th quation Th Mod of Coën 200: Intoduction of Human Capita Th objcti is to tst if th intoduction of human capita into an Intnationa CAPM, pains domstic bias. Fo that, w wi bas ou anaysis on th mod of Coën 200 which taks into account th istnc of human capita. To di his mod, th autho intoducd th assumption that human capita tun wags of th insto foows a stationay pocss: dh hdt hdz 6 h H H : Th wag au of insto ; h : Th instantanous pctd at of aiation of th wag; h : Th standad diation of th instantanous at of th wag; z h : A standad Win Pocss; dz h : A whit nois. Th autho aso supposs that th tota incom of ach insto coms fom financia soucs and human capita with spcti popotions and. Using th pincip of Bman to so this pobm, Coën 200 dis th ation of th optima potfoio: 8 ISSN 96-97X E-ISSN

4 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun ' ' ' : N Vcto of coaiancs of N isky asst tuns with insto s at of chang of th wag. i,h Thus, th optima potfoio of indiidua insto bcoms a combination of th funds: Th ogaithmic potfoio which is common fo a instos; Th psonaizd hdg potfoio which constituts th bst hdging against infation fo th insto ; Th psonaizd hdg potfoio psonaizd which constituts th bst hdging against th aiation of th wag. Using a mthod idntica to that psntd in th pcding sction, w obtain th foowing ation: 8 This quation indicats that th diations of insto s potfoio fom th wodwid potfoio a popotiona to two ctos of th cofficints of gssion. This quation diffs fom th quation 5 wh, th scond tm is atd to wags. 4. Empiica Rsuts 4. Data Dsciption Th data bas is consistd on th quity makt tuns, th consumption pic indics and th abo incom ats fo Canada, Fanc, Itay, Japan, Nthands, Spain, Swdn, Unitd Kingdom and Unitd Stats. Th stock makt indics a poidd by Mogan Stany Capita Intnationa Pspcti [MSCI].and pssd in Amican doa th L+st cuncy. Makt capitaizations at Dcmb 3st, 2003 com fom Wod Fdation of Echangs and MSCI. Th data on domstic and foign hodings of instos a tactd fom Coodinatd Potfoio Instmnt Suy pubishd by Intnationa Montay Fund [IMF]. Th pic inds as w as th abo incom ats usd as poy of th human capita a fom th Intnationa Financia Statistics of IMF. Th data usd a of monthy fquncy fo th piod Dcmb 969 to Dcmb Masu of Equity Hom Bias Wanock 2002 poposd a masu of quity hom bias so that th bias is qua to zo if th sha of insto s potfoio in domstic scuitis is qua to th sha of th county in wod potfoio. If it is qua to, th instos hod ony domstic scuitis. Sha of foign quitis in insto' s potfoio Hom bias - 9 Sha of foign quitis in wod potfoio W masu th insto potfoio by domstic makt capitaization pus th au of quitis hd by domstic instos aboad minus th au of quitis hd by foign instos in domstic county. W consid that wod makt capitaization is th sum of makt capitaizations of th 9 dopd makts of ou samp. Tab psnts th componnts of th bias aiab fo th 9 countis: Pubishd by Canadian Cnt of Scinc and Education 9

5 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Tab. Hom Bias Masus at Dcmb 2003 County Sha of county in Sha of domstic quitis in Sha of foign quitis in Hom bias quity wod makt capitaization insto s potfoio insto s potfoio Canada Fanc Itay Japan Nthands Spain Swdn Unitd Kingdom Unitd Stats Tota Th suts of tab show a stong pfnc by instos fo domstic quitis. Th bias is positi and cds 0.5 fo a th countis, cpt fo th Nthands and Fanc. This phnomnon is y impotant fo Canada, Japan and Spain. 4.3 Hom Bias Tst with Infation Hdging W un th gssions with cofficints cosponding to th ight-hand sid mmbs of th quation 5: N p p b b R u,..., L 0 t 0 it t i Th th cofficint of this gssion is an stimat of th domstic bias diidd by on minus th isk toanc. Thfo, b can b wittn as foows: b W substitut fo obtain: b in th quation 0 and w us th wath of ach county as a poy of makt capitaization, w p p b0 b R t N i it W stimat th cofficints of isk asion by using th gnaizd momnt mthod GMM of Hansn 982, which cocts htoscdasticity and sia coation. In this cas, w us th tuns as instumnta aiabs. Bfo psnting th suts of this gssion, w pos som dscipti statistics fo infation diations of diffnt countis. This aiab is th diffnc btwn infation at of a county and th aag of infation ats of th 9 countis. R it t u 2 20 ISSN 96-97X E-ISSN

6 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Tab 2. Dscipti statistics of infation diations County Man Standad Diation Autocoations Canada Fanc Itay Japan Nthands Spain Swdn Unitd Kingdom Unitd Stats E It is dducd fom th tab 2 that infation diation is positi fo Spain, Fanc, Itay, th Unitd Kingdom and Swdn. It is how mo impotant fo Spain and Itay wh infation is high than th aag of th countis. Th cofficints of autocoation of fist od a significanty diffnt fom zo fo a th countis, which show th pdictab chaact of th infation ats. Th suts of stimat of th quation 2 a gin in tab 3. Tab 3. Tst of hom bias by th moti of infation hdging County Standad Diation of Pobabiity that b 0 and 0 Canada Fanc Itay Japan Nthands Spain Swdn Unitd Stats Unitd Kingdom Th stimats of isk asion cofficints a y wak. Concning th hypothsis which cosponds to th hdging infation, w qui that b 0, which indicats that th tun of domstic financia makt is positiy coatd with infation at and that 0, maning a positi isk asion. Fo ach county, w tst th joint hypothsis that b 0 and 0 : Th popotion of th potfoio instd in domstic financia; : Th popotion of th county in wod makt capitaization; : Th stimat of th ati isk asion cofficint; Th autocoation and th htoscdasticity of os a coctd by th tst of Nwy and Wst 987 with 2 ags cosponding to th piodicity of sis. Th ast coumn of tab 3 psnts th pobabiity that th domstic bias is causd by th hdging infation isk. Fo a th countis, th is a nu pobabiity that th joint hypothsis is aidatd. Thfo, th hdging of isk infation dos not pain th puzz of domstic bias. 4.4 Tst of Intnationa CAPM with Human Capita W wi adopt th sam appoach as that usd piousy. W thus consid th foowing systm: Pubishd by Canadian Cnt of Scinc and Education 2

7 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 h h N p p t b0 b Rit b R it u t i 3 dh h H Tab 4. Tst of hom bias by th moti of infation hdging and human capita County Standad Diation of Pobabiity that b 0 and 0 Canada Fanc Itay Japan Nthands Spain Swdn Unitd Stats Unitd Kingdom Th suts show that fo th 9 countis, and th cofficint of ati isk asion, a not jointy significanty positi. Th is a nu pobabiity that th joint hypothsis is tu. How, w not that th cofficints of ati isk asion fo Canada and Spain a significanty diffnt fom zo on th of 5%. In spit of this sut, w can concud that th hdging of isk infation and th hdging of changs in th wag can b jctd as an panation of hom bias puzz. Ou study is cohnt with th pcding studis and in paticua that of Bat and Gman Concusion Th intnationa financia itatu showd that instos a und disifid in intnationa scuitis. This bhaio cad hom bias, psnts sa panations in th financia itatu. In this pap, w choos to tst th domstic bias by using th mod of Ad and Dumas 983 which taks into account th diations fom pow paity. W amind th hypothsis that th pfnc fo nationa assts is causd by th infation hdging, w thus tstd th assumption that th stock chang tun of a county is positiy coatd with its infation at and that th cofficint of isk asion is sticty positi. By appying this mod to nin dopd countis, th suts show that th hdging of domstic infation dosn t pain th puzz of hom bias, fo th piod , which confims th suts of Coop and Kapanis 994. Th cnt studis undin th o of human capita in th potfoio choic, it is fo this ason, w basd on th study of Coën 200, which constituts an tnsion of Ad and Dumas 983 in od to so th puzz of domstic bias by infation hdging and human capita. Th mod of Coën 200 supposs that optima potfoio is composd of th funds: th ogaithmic potfoio, th infation hdg potfoio and th hdg potfoio against chang in abo incom. A ngati coation btwn th tun of human capita and th tuns of nationa scuitis shoud incas th nationa bias. Th suts of th tst of Intnationa CAPM with human capita show that th hdging infation isk and th changs of wags can t pain th puzz of hom bias. Th psnc of human capita is impotant in intnationa potfoio choic how its contibution to th panation of domstic bias is wak. It coud thus b intsting to sk oth panations. Futu sach on domstic bias cannot igno th o of tansaction cost in county aocation dcisions. Moo, asymmty of infomation btwn domstic and foign instos is on of th impotant chaactistics of financia makts and coud contibut to pain th puzz of hom bias. 22 ISSN 96-97X E-ISSN

8 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 Rfncs Ad, M., & Dumas, B Intnationa Potfoio Choic and Copoation Financ: a Synthsis. Jouna of Financ, 38, Amadi, A., & Bgin, P. R Undstanding intnationa potfoio disification and tuno ats. Intnationa Financia Makts Institutions and Mony, 8, Baon, J. M., & Ni, J Endognous Asymmtic Infomation and Intnationa Equity Hom Bias: Th Effcts of Potfoio Siz and Infomation Costs. Jouna of Intnationa Mony and Financ, 27, Bat, M., & Jmann, U. J Th Intnationa Disification Puzz is Woth than you think. Amican Economic Riw, 87, Baah, Ma., & Aboua, S Th ffct of Asymmtic Infomation and Tansaction Costs on Asst Picing: Thoy & Tsts. Intnationa Jouna of Businss,, Cai, F., & Wanock, F. E Intnationa Disification at Hom and Aboad. NBER Woking Pap, no Cho, H., Kho, B., & Stuz, R Do Domstic Instos Ha Mo Vauab Infomation About Indiidua Stocks Than Foign Instos?. NBER Woking Pap, no Coën, A Hom Bias and Intnationa Capita Asst Picing Mod with Human Capita. Jouna of Mutinationa Financia Managmnt,, Coop, I., & Kapanis, K Costs of Cossbod Instmnt and Intnationa Equity Makt Equiibium. Jmy Edwads Edition, Rcnt Adancs in Copoat Financ. Cambigd Unisity Pss, Cambig. Fnch, K., & Potba, J. 99. Insto Disification and Intnationa Equity Makts. Amican Economic Riw, 8, Gau, F. L. A., Litznbg, R. H., & Sth, R. S Shaing Rus and Equiibium in an Intnationa Capita Makt und Unctainty. Jouna of Financia Economics, 3, Hay, C Pdictab Risk and tuns in Emging Makts. Woking Pap, Duk Unisity. Kang, J., & Stuz, R Why is th a Hom Bias? An Anaysis of Foign Potfoio Equity in Japan. Jouna of Financia Economics, 46, Lwis, K Intnationa Hom Bias in Intnationa Financ and Businss Cycs. NBER Woking Pap, no 635. Mondia, J., & Wu, T Th puzzing oution of th hom bias, infomation pocssing and financia opnnss. Jouna of Economic Dynamics and Conto, 34, Scu, P A Gnaisation of th Intnationa Asst Picing Mod. Ru d Association Fançais d Financ,, Sonik, B An Equiibium Mod of th Intnationa Capita Makt. Jouna of Economic Thoy, 8, Vassaou, M Echang Rat and Foign Infation Risk Pmiums in Goba Equity Rtun. Jouna of Intnationa Mony and Financ, 9, Wanock, F Hom Bias and High Tuno Rconsidd. Jouna of Intnationa Mony and Financ, 2, Nots Not. Th US makt psnts th domstic makt and ind EAFE psnts th foign makt. Not 2. Accoding to Ad and Dumas 983, w aso suppos that N+ asst is nominay iskss and that N-L fist assts constitut stock scuitis and th L ast constitut bonds. Not 3. Basing on quation 3, w can wit: Pubishd by Canadian Cnt of Scinc and Education 23

9 Intnationa Jouna of Economics and Financ Vo. 4, No. 6; Jun 202 ISSN 96-97X E-ISSN How Thus /

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