International Portfolio Diversification and the Home Bias Puzzle

Abstract

We review the literature on equity home bias, a phenomenon stating that investors do not hold enough foreign equities for an optimally diversified portfolio. We begin by defining the home bias measurement and reviewing related evidence on the bias. Further, we consider four explanations for this puzzling phenomenon: barriers to foreign investment, country-specific risks, information asymmetry, and cultural and behavioral factors. We analyze the related theoretical arguments and empirical findings of prior studies within each explanation. Based on the discussion of previous studies, several avenues for future research are suggested. (JEL G11, G15, F41)