The determinants of home bias

Abstract

Despite the well-known gains of the international diversification, investors have the tendency to overinvest in domestic equities. This irrational behavior is called home bias. It is considered by Obstfeld and Rogoff (2000) as one of the six major puzzles in the international macroeconomics. The present paper examines the different determinants to understand this major puzzle. Based on a sample of 564 observations (countries-years) that cover the period 2003 to 2013, we found that home bias is explained by the information asymmetry that exists between countries and their economic volatility (assessed by the growth rate of the gross domestic product). Furthermore, our findings indicate that home bias decreases among developed markets and countries characterized by a higher rule of law.