Equity home bias: Can information cost explain the puzzle?

The purpose of this article is to raise the awareness of the number of empirical and theoretical issues concerning home bias in equity holdings. Generally, people believe that home bias in the U.S. is more severe than in other countries, basing their views on raw data about holdings of foreign assets. But a more comprehensive measure of home bias, the implicit shadow cost of foreign investment, reveals that the U.S. has the lowest home bias among all industrialized nations. A frequently cited cause of home bias is the cost of information that investors face if they want to invest in foreign equity markets. While this explanation is intuitive, it is demonstrated that the theory is unable to account for observed patterns of home bias through the use of both a naive model and a rational expectations model.