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Risk Appetite, Home Bias and the Unstable Demand for Emerging Market Assets

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  • Sofia Babilis
  • Valpy Fitzgerald

Abstract

Home bias arises when the actual portfolio of an investor consists of a smaller proportion of foreign assets than that predicted by standard portfolio theory for the observed set of risks and returns on available assets. The existence and persistence of home bias undermines the theoretical case for the efficiency of international capital markets. In this paper we use data on UK pension fund portfolios to measure home bias, and find that this is doubly acute in the case of emerging market equity—a bias against overseas assets as a whole being further magnified by a bias against emerging markets within the foreign equity class as a whole. Moreover, contrary to the conventional assumption that risk aversion is both relatively low and stable over time (canonised in neoclassical theory by the derivation of constant relative risk aversion from the utility function itself) our finding that home bias fluctuates over time suggests that risk aversion is in fact time-variant and path-dependent. We sketch an alternative Keynesian approach in conclusion.

Suggested Citation

  • Sofia Babilis & Valpy Fitzgerald, 2005. "Risk Appetite, Home Bias and the Unstable Demand for Emerging Market Assets," International Review of Applied Economics, Taylor & Francis Journals, vol. 19(4), pages 459-476.
    • Handle: RePEc:taf:irapec:v:19:y:2005:i:4:p:459-476
    DOI: 10.1080/02692170500213335
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    References listed on IDEAS

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    4. Ahearne, Alan G. & Griever, William L. & Warnock, Francis E., 2004. "Information costs and home bias: an analysis of US holdings of foreign equities," Journal of International Economics, Elsevier, vol. 62(2), pages 313-336, March.
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    6. Mr. Manmohan S. Kumar & Mr. Avinash Persaud, 2001. "Pure Contagion and Investors Shifting Risk Appetite: Analytical Issues and Empirical Evidence," IMF Working Papers 2001/134, International Monetary Fund.
    7. Valpy Fitzgerald & Derya Krolzig, 2003. "Modeling the Demand for Emerging Market Assets," Economics Series Working Papers 2003-FE-10, University of Oxford, Department of Economics.
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