Domestic versus International Portfolio Selection: A Statistical Examination of the Home Bias

Larry R. Gorman () and Bjørn Jørgensen
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Larry R. Gorman: California Polytechnic State University, U.S.A.

Multinational Finance Journal, 2002, vol. 6, issue 3-4, 131-166

Abstract: The observed international home bias has traditionally been viewed as an anomaly. This paper provides statistical evidence contrary to this view within a mean-variance framework. Two methods of estimating the expected return and covariance parameters are investigated: (i) the traditional Markowitz approach, and (ii) the Bayes-Stein "shrinkage" algorithm. In-sample tests reveal that neither the Markowitz tangency allocation vectors nor the Bayes-Stein tangency allocation vectors are significantly different than a 100% domestic allocation (i.e. extreme home bias). These results are robust to the shorting of equity and across foreign exchange hedge strategies. The paper also reports out-of-sample tests with a view toward investment performance. Typically, a 100% domestic allocation outperforms both the Bayes-Stein and Markowitz tangency portfolios. Overall, the theorized gains to international diversification appear difficult to capture in practice and, hence, investors exhibiting a strong home bias are not necessarily acting irrationally.

Keywords: efficient allocation; foreign exchange hedging; home bias; international allocation; portfolio (search for similar items in EconPapers)
JEL-codes: F3 G11 G12 G15 (search for similar items in EconPapers)
Date: 2002
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Citations: View citations in EconPapers (22)

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Persistent link: https://EconPapers.repec.org/RePEc:mfj:journl:v:6:y:2002:i:3-4:p:131-166

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