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Quantitative Implications of the Home Bias: Foreign Underinvestment, Domestic Oversaving, and Corrective Taxation

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  • Assaf Razin
  • Efraim Sadka
  • Chi-Wa Yuen

Abstract

There is strong evidence about a home-court advantage in international portfolio investment. One explanation for the bias is an information asymmetry between domestic and foreign investors about the economic performance of domestic firms. This asymmetry causes two types of distortions: an aggregate production inefficiency and a production-consumption inefficiency, leading to foreign underinvestment and domestic oversaving respectively. Such market failures are found to be quite severe, slightly more so with equity flows than with debt flows. These inefficiencies can nonetheless be corrected by a mix of tax-subsidy instruments, consisting of taxes on corporate income and on the capital incomes of both residents and nonresidents. When only a partial set of instruments is available, however, the prescription for each tax instrument can change radically and may even be reversed although the welfare gains can be fairly substantial and sometimes close to the first best optimum. This partial set of instruments appears to be more effective in handling the market failure in the case of equity flows than in the case of debt flows.

Suggested Citation

  • Assaf Razin & Efraim Sadka & Chi-Wa Yuen, "undated". "Quantitative Implications of the Home Bias: Foreign Underinvestment, Domestic Oversaving, and Corrective Taxation," EPRU Working Paper Series 97-27, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:epruwp:97-27
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    References listed on IDEAS

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    1. Razin, Assaf & Sadka, Efraim & Yuen, Chi-Wa, 1998. "A pecking order of capital inflows and international tax principles," Journal of International Economics, Elsevier, vol. 44(1), pages 45-68, February.
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    7. Assaf Razin & Efraim Sadka & Chi-Wa Yuen, 1997. "Channeling Domestic Savings into Productive Investment Under Asymmetric Information: The Essential Role of Foreign Direct Investment," NBER Working Papers 6338, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Mishra, Anil V. & Ratti, Ronald A., 2013. "Home bias and cross border taxation," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 169-193.

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    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements

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