Home Bias Puzzle the Home Essay

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This gives Toronto investors a competitive advantage in mining investing, which will be reflected in a home bias. As Van Nieuwerburgh & Veldkamp (2007) explain, home investors have a bias because they have information that non-home investors do not have. These information asymmetries persist, even with today's global information pipelines. The cost of information can be quite high, despite the relatively rapidity of its diffusion among global investors.

There are other potential explanations. Campbell and Kraussl (2007) posited that international investing carries with it the perception of increased downside risk. This can come from time zone differences, speed of information diffusion or translation issues in non-English-speaking markets. Whatever the concern, it is reasonable that international investing suffers as a result of increased perceived risk, even if that perception is not born out by reality.

Another possible explanation is that investors are irrational. While the rational investor may understand that international diversification is valuable, an irrational investor may not care. It is important to remember that the rational investor is a construct of economic academia. In the real world, investors can be highly irrational, as evidenced by multiple bubbles and panics in the past dozen years.

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It is likely that home bias is a puzzle in part because investors are expected to be rational when they are not, but also as a result of the other theories as well. Ahearne, Griever and Warnock (2004) showed that foreign firms with U.S. listings tend to receive due weighting in U.S. equity portfolios. Those that do not have U.S. listings are severely underweighted. This reflects both information costs, associated with gathering, vetting and translating information about foreign companies and transliterating their financial statements. It also reflects transaction costs. A foreign firm listed on the NYSE is just as easy to trade as a domestic firm. It is reasonable that if a foreign firm produced financial statements that were in line with U.S. GAAP but maintained listing only overseas, that the firm would remain severely underweighted. Such a hypothesis, if proven, could provide new directions to unlock the home bias puzzle.

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