Foreign bias in equity portfolios: Informational advantage or familiarity bias?

We use the European Central Bank's new and detailed database of European equity holdings by households to test two competing theories of international biases in equity portfolios, viz. that they reflect either informational advantages or familiarity bias. The database allows lookthrough handling of investments via mutual funds and the like, and reveals that home bias is smaller than usually believed. We find that both home bias and foreign bias are positively associated with the Cremers and Petajisto (2009) ActiveShare measure and negatively with the fraction of the country sub-portfolio invested via mutual funds, both of which are consistent with information effects rather than familiarity bias. Again consistent with the information hypothesis, we further find a positive relationship between excess returns and ActiveShare, as well as higher expected returns when foreign bias is positive rather than negative. Given the investor's place of residence, nationality has no impact, so portfolios per nationality group within a country provide additional test material.