Home asset bias / Equity Home Bias Puzzle

The concept of home asset bias (home market preference) or Equity Home Bias Puzzle signifies the tendency of investors to allocate disproportionate weight to investments in the home market.




Background

The modern portfolio theory states that the asset composition, the allocation of money between various (mutually statistically independent) investment categories, leads to an increase in revenue. On the basis of this theory,. distribution of investment amounts in. portfolio across. multitude of national markets would be useful.

In practice, however, it is observed that investors invest. disproportionately large part of their assets in their respective home market. This effect is called the home bias. The effect was first described by Kenneth French and James M. Poterba (1991), as well as by Linda Tesar andIngrid Werner.

What causes home asset bias

The following aspects are mentioned as causes for the home asset bias:

Transaction costs
With. financial investment abroad, higher transaction costs are involved. When these costs are avoided, the profitability increases.

Information deficit
Generally investors are relatively well informed about operating in the home market and therefore think they can assess the opportunities and risks. In foreign markets, investors usually have less information.

Exchange rate risk
The profit for investors is partly determined by the yield of the investment itself, but also by fluctuating the exchange rate. An investment in an area with the same currency is therefore risk-free.

Double tax
Financial risk or extra administrative burden due to foreign withholding tax.

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