The equity home bias puzzle in the context of the European debt crisis
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Plamadeala, Rodica1, Forfatter
Sebald, Alexander2, Vejleder
1Det Samfundsvidenskabelige Fakultet, Københavns Universitet, København, Danmark, diskurs:7001              
2Økonomisk Institut, Det Samfundsvidenskabelige Fakultet, Københavns Universitet, København, Danmark, diskurs:7014              
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Ukontrollerede emneord: Equity home bias, European debt crisis, behavioural finance, ambiguity aversion, information asymmetry, familiarity, Eurozone periphery, international diversification, panel data
 Abstract: Finance theory suggests that investors should hold an internationally diversified portfolio, but in practice investors tend to overweight domestic assets in their investment portfolio. The purpose of this thesis is to study the evolution of the equity home bias puzzle in the context of the European financial and sovereign debt crisis with a special focus on the euro area peripheral countries (Greece, Ireland, Portugal, Italy and Spain). The aim of this paper is to investigate if a mixture of asymmetric information and behavioural factors can explain the observed home bias, particularly under the uncertainty caused by the post-2008 turmoil.

First, I measure the equity home bias for 45 countries by using an adapted version of the most common formula in the empirical literature which ranks countries from zero (no home bias) to one (no international diversification). I find considerable variation across countries, with investors in big emerging markets being much more inward-looking than their peers in Northern Europe. Moreover, I show that home bias experienced a general downward trend over the analysed period, with most of the drop occurring during the financial crisis. Next, I calculate the pair-wise bilateral home bias between 38 home countries and 77 destination countries and use these values to perform a panel regression analysis which studies the role of asymmetric information and investor behaviour on the bilateral home bias.

I find that countries which are geographically close and which share various cultural traits, such as a common language or religion, are generally much less home biased towards each other, strongly supporting the asymmetric information hypothesis. I also find a significant availability effect, indicating that countries with large equity markets relative to GDP tend to be more home biased, especially during times of market stress. The thesis adds to the empirical evidence supporting the hypothesis that behavioural factors also represent important sources of home bias. The first behavioural factor considered, familiarity, is found to be relevant in explaining the observed bilateral home bias measures, showing that investors prefer to allocate more of their equity portfolios towards countries with which they feel more familiar. Trade links are found to be especially powerful, with an increase of 1 percentage point in bilateral trade as a share of the target country’s GDP being associated, on average, with a 0.5% lower bilateral home bias. The second behavioural factor considered, namely ambiguity aversion, is also found to play a role in the observed degree of international diversification, but only during the financial crisis, suggesting that uncertainty regarding the prospects of a target country’s equity markets matters only during times of turmoil.

One of the noteworthy contributions of this thesis to the existing empirical literature is its quantification of the effects of the European debt crisis on the equity home bias puzzle. First, I prove the existence of the well-known ”EMU effect” , which according to my estimations corresponds, all things being equal, to a 23.5% lower bilateral home bias between countries sharing membership in the Eurozone. Second, I uncover a previously unknown effect, dubbed the “peripheral effect”, which indicates that investors from the so-called peripheral euro area countries were nudged into diversifying more abroad by the domestic market turmoil. I show that before the crisis, these countries had, on average a 23.3% larger home bias than the rest of the world. After controlling for the previously discovered factors, I find that their home bias fell during 2008-2011 with 2.3% more than for other non-peripheral countries, suggesting that the European debt crisis may have had an additional impact on their observed equity home bias that is not captured by observable variables.
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 Type: Speciale
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Sprog: English - eng
 Datoer: 2014-03-01
 Sider: -
 Publiceringsinfo: København : Københavns Universitet
 Indholdsfortegnelse: 1. Introduction 1
2. Literature review and sources of home bias 5
2.1. Institutional barriers to international investments 7
2.1.1. Implicit and explicit costs of foreign investments 7
2.1.2. Hedging domestic risk 11
2.1.3. Corporate governance 13
2.2. Information asymmetries . 14
2.3. Behavioural factors 20
2.3.1. Ambiguity aversion 20
2.3.2. Familiarity 22
2.4. Summary of Chapter 2 24
3. World financial crisis and the European debt crisis 25
3.1. The Storm . 25
3.2. The Storm’s aftermath in the European Union 27
3.3. The Storm’s consequences in the euro area peripheral countries 30
3.4. Summary of Chapter 3 34
4. Theoretical framework: the equity home bias 35
4.1. How to measure the equity home bias? 35
4.2. Optimal Portfolio Weight Models . 36
4.2.1. The Model-Based Approach . 36
4.2.2. The Data-Based Approach 37
4.2.3. Other approaches . 38
4.2.4. Why did I choose ICAPM? 39
4.3. Data and variables description 40
4.4. Summary of Chapter 4 49
5. Empirical results 50
5.1. Stylised facts . 50
5.2. Determinants of the equity home bias 54
5.2.1. Summary statistics 54
5.2.2. Model specification 56
5.2.3. Estimation results . 59
5.3. Robustness check . 63
5.4. Comparing the empirical results with previous findings . 65
5.5. Summary of Chapter 5 67
6. Conclusion 68
Bibliography 71
A. Appendix 78
A.1. Summary statistics 78
A.2. European debt crisis charts 81
A.3. Data description 85
A.4. Robustness check . 90
 Note: -
 Type: Speciale
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