ABSTRACT
Extant research presents clear evidence that investors prefer to invest in domestic stock markets to a far greater extent than is suggested by theoretical models (French and Poterba 1991), and in effect it documents a ‘home bias’ in equity portfolios. As a consequence, investors on average forego the diversification benefits of allocating resources on foreign markets (Grubel 1968). Various explanations for this phenomenon have been proposed (Lewis 1999; Sercu and Vanpée 2007), most of which attribute such divergence to a rational underlying factor. The fact that most investors overweight local assets in their portfolios means that their allocations in most foreign markets are sub-optimal, and thus a ‘foreign bias’ exists. However, investors do not discriminate foreign markets uniformly, that is some markets are less underweighted than others. Chan, Covrig, and Ng (2005) test a wide range of explanations for this variation and conclude that investors are more eager to allocate funds in countries that are more familiar and have more developed stock markets.
