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Home bias and high turnover reconsidered

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Author Info
Francis E. Warnock
Abstract

It is a stylized fact of international finance that foreign equities are underweighted (the home bias) but overtraded (the high turnover). Since stylized facts drive research, theoretical models are now developed to explain the puzzling coexistence of home bias and high turnover, first presented in Tesar and Werner (1995), and researchers now dismiss transaction costs as a plausible explanation of home bias. I show, however, that part of the puzzle--very high turnover rates on foreign equity portfolios--is based on inaccurate estimates of cross-border holdings. Revised estimates of holdings of foreign equities from comprehensive benchmark surveys produce foreign turnover rates that are much lower than previously reported and are comparable to domestic turnover rates. The implications of this finding are clear. First, researchers should no longer develop theoretical models to explain the coexistence of home bias and high turnover. Second, the relationship between transaction costs and home bias should be reexplored. On the second point, the basic intuition from Tesar and Werner (1995)--that transaction costs do not help explain the observed home bias--is confirmed using actual data on transaction costs in 41 markets.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 702.

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Date of creation: 2001
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Handle: RePEc:fip:fedgif:702

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Keywords: International finance ; Capital movements;

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References listed on IDEAS
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. P Martin & H Rey, 2000. "Financial Integration and Asset Returns," CEP Discussion Papers dp0451, Centre for Economic Performance, LSE. [Downloadable!]
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  2. 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)
  3. Michael J. Brennan. and H. Henry Cao., 1997. "International Portfolio Investment Flows," Research Program in Finance Working Papers RPF-271, University of California at Berkeley. [Downloadable!]
  4. 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)
  5. Massimo Guidolin, 2005. "Home Bias and High Turnover in an Overlapping-generations Model with Learning," Review of International Economics, Blackwell Publishing, vol. 13(4), pages 725-756, 09. [Downloadable!] (restricted)
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  6. Rowland, Patrick F., 1999. "Transaction costs and international portfolio diversification," Journal of International Economics, Elsevier, vol. 49(1), pages 145-170, October. [Downloadable!] (restricted)
  7. Brennan, Michael J & Cao, H Henry, 1997. " International Portfolio Investment Flows," Journal of Finance, American Finance Association, vol. 52(5), pages 1851-80, December. [Downloadable!] (restricted)
  8. Alaganar, V. T. & Bhar, Ramaprasad, 2001. "Diversification gains from American depositary receipts and foreign equities: evidence from Australian stocks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 11(1), pages 97-113, March. [Downloadable!] (restricted)
  9. 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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  1. Bravo-Ortega, Claudio, 2005. "Does asymmetric information cause the home equity bias?," Policy Research Working Paper Series 3495, The World Bank. [Downloadable!]
  2. Catherine L. Mann & Ellen E. Meade, 2002. "Home Bias, Transaction Costs, and Prospects for the Euro: A More Detailed Analysis," Peterson Institute Working Paper Series WP02-3, Peterson Institute for International Economics. [Downloadable!]
  3. Shujing Li & Isabel K. Yan & Hamid Faruqee, 2004. "The Determinants of International Portfolio Holdings and Home Bias," IMF Working Papers 04/34, International Monetary Fund. [Downloadable!]
  4. Michael Fidora & Marcel Fratzscher & Christian Thimann, 2006. "Home bias in global bond and equity markets - the role of real exchange rate volatility," Working Paper Series 685, European Central Bank. [Downloadable!]
    Other versions:
  5. Massimo Guidolin, 2005. "Home bias and high turnover in an overlapping generations model with learning," Working Papers 2005-012, Federal Reserve Bank of St. Louis. [Downloadable!]
    Other versions:
  6. Francis E. Warnock & Chad Cleaver, 2002. "Financial centers and the geography of capital flows," International Finance Discussion Papers 722, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  7. Lee Pinkowitz & Rene M. Stulz & Rohan Williamson, 2001. "Corporate Governance and the Home Bias," NBER Working Papers 8680, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Sofia Babilis & Valpy Fitzgerald, 2005. "Risk Appetite, Home Bias and the Unstable Demand for Emerging Market Assets," International Review of Applied Economics, Taylor and Francis Journals, vol. 19(4), pages 459-476, October. [Downloadable!] (restricted)
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