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Home bias in global bond and equity markets - the role of real exchange rate volatility

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Author Info
Michael Fidora () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
Marcel Fratzscher () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
Christian Thimann () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)

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Abstract

This paper focuses on the role of real exchange rate volatility as a driver of portfolio home bias, and in particular as an explanation for differences in home bias across financial assets. We present a Markowitz-type portfolio selection model in which real exchange rate volatility induces a bias towards domestic financial assets as well as a stronger home bias for assets with low local currency return volatility. We find empirical support in favour of this hypothesis for a broad set of industrialised and emerging market countries. Not only is real exchange rate volatility an important factor behind bilateral portfolio home bias, but we find that a reduction of monthly real exchange rate volatility from its sample mean to zero reduces bond home bias by up to 60 percentage points, while it reduces equity home bias by only 20 percentage points. JEL Classification: F30, F31, G11, G15.

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Paper provided by European Central Bank in its series Working Paper Series with number 685.

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Length: 46 pages
Date of creation: Oct 2006
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Handle: RePEc:ecb:ecbwps:20060685

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Keywords: Home bias exchange rate volatility risk portfolio investment global financial markets capital flows.

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  6. Fang Cai & Francis E. Warnock, 2004. "International diversification at home and abroad," International Finance Discussion Papers 793, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  7. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June. [Downloadable!] (restricted)
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  23. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August. [Downloadable!] (restricted)
  24. Bong-Chan Kho & René M. Stulz & Francis E. Warnock, 2006. "Financial Globalization, Governance, and the Evolution of the Home Bias," NBER Working Papers 12389, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  28. Francis E. Warnock, 2001. "Home bias and high turnover reconsidered," International Finance Discussion Papers 702, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  30. Kang, Jun-Koo & Stulz, Rene M., 1997. "Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan," Journal of Financial Economics, Elsevier, vol. 46(1), pages 3-28, October. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Dimitrios Christelis & Dimitris Georgarakos, 2008. "Investing at Home and Abroad: Different Costs, Different People?," CSEF Working Papers 188, Centre for Studies in Economics and Finance (CSEF), University of Salerno, Italy. [Downloadable!]
  2. Fratzscher, Marcel & Imbs, Jean, 2007. "Risk Sharing, Finance and Institutions in International Portfolios," CEPR Discussion Papers 6496, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
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