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Trying to Explain Home Bias in Equities and Consumption

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  • Karen K. Lewis

Abstract

Investors hold a substantially larger proportion of their wealth portfolios in domestic assets than standard portfolio theory would suggest, a phenomenon called "equity home bias." In the absence of this bias, investors would optimally diversify domestic output risk using foreign equities. Therefore, consumption growth rates would tend to co-move across countries even when output growth rates do not. Empirically, however, consumption growth rates tend to have a lower correlation across countries than do output growth rates, a phenomenon I call "consumption home bias." In this paper, I discuss these two biases and their potential relationship as suggested by the literature.

Suggested Citation

  • 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.
  • Handle: RePEc:aea:jeclit:v:37:y:1999:i:2:p:571-608
    Note: DOI: 10.1257/jel.37.2.571
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    References listed on IDEAS

    as
    1. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
    2. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    3. Dumas, Bernard & Solnik, Bruno, 1995. " The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-479, June.
    4. Larry R. Gorman & Bjorn N. Jorgensen, 2002. "Domestic versus International Portfolio Selection: A Statistical Examination of the Home Bias," Multinational Finance Journal, Multinational Finance Journal, vol. 6(3-4), pages 131-166, September.
    5. Telmer, Chris I, 1993. " Asset-Pricing Puzzles and Incomplete Markets," Journal of Finance, American Finance Association, vol. 48(5), pages 1803-1832, December.
    6. Bekaert, Geert, 1994. "Exchange rate volatility and deviations from unbiasedness in a cash-in-advance model," Journal of International Economics, Elsevier, vol. 36(1-2), pages 29-52, February.
    7. Stockman, Alan C & Tesar, Linda L, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," American Economic Review, American Economic Association, vol. 85(1), pages 168-185, March.
    8. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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