An Information Based Explanation of the Domestic Bias in International Equity Investment

Thomas P. Gehrig

389 citations0/0 files storedScandinavian Journal of Economics

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Financial Markets and Investment Strategies Global Financial Crisis and Policies Economic theories and models

Abstract

The domestic bias in international equity investment presents a major challenge to asset pricing models building on the assumption of symmetrically informed investors. Some further evidence on the home bias is provided and the question of why foreign exchange risk or capital controls are not sufficient to explain the full effect is discussed. A simple noisy rational expectations model is introduced where, even in equilibrium, investors remain incompletely informed. It is shown that the domestic bias arises quite naturally when investors are on average better informed about domestic stocks.

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1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1983International Portfolio Choice and Corporation Finance: A Synthesis 1980On the aggregation of information in competitive markets 1974An equilibrium model of the international capital market 1985International Asset Pricing under Mild Segmentation: Theory and Test 1985A Noisy Rational Expectations Equilibrium for Multi-Asset Securities Markets 1979Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices

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