Confidence in the Familiar: An International Perspective

Investors have long exhibited a “home country bias” whereby they hold more shares of firms from their own country than would seem warranted based off of typical diversification theory. This seeming anomaly has been partially explained in many ways (my favorite is Butler’s view that when markets fall, the correlation is actually greater than the long run correlation, hence overstating the value of diversification). Li looks at this from a different perspective by trying to examine how risky the foreign marklets would have to be before investor behavior would make sense. He finds that “in order to hold predominantly domestic equities, each G7 investor has to believe that the risk of foreign investment is several times higher than the actual risk.” [FinanceProfessor.com Annotation]