Home bias and high turnover reconsidered

Francis Warnock

No 702, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: It is a stylized fact of international finance that foreign equities are underweighted (the home bias) but overtraded (the high turnover). Since stylized facts drive research, theoretical models are now developed to explain the puzzling coexistence of home bias and high turnover, first presented in Tesar and Werner (1995), and researchers now dismiss transaction costs as a plausible explanation of home bias. I show, however, that part of the puzzle--very high turnover rates on foreign equity portfolios--is based on inaccurate estimates of cross-border holdings. Revised estimates of holdings of foreign equities from comprehensive benchmark surveys produce foreign turnover rates that are much lower than previously reported and are comparable to domestic turnover rates. The implications of this finding are clear. First, researchers should no longer develop theoretical models to explain the coexistence of home bias and high turnover. Second, the relationship between transaction costs and home bias should be reexplored. On the second point, the basic intuition from Tesar and Werner (1995)--that transaction costs do not help explain the observed home bias--is confirmed using actual data on transaction costs in 41 markets.

Keywords: International finance; Capital movements (search for similar items in EconPapers)
Date: 2001
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (16)

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