This paper examines the home bias puzzle in investing—the well-documented tendency of investors to prefer domestic equities over foreign ones, despite empirical evidence that broader geographic diversification reduces risk and improves returns. Drawing on key academic research, the paper evaluates several competing explanations: the higher transaction costs and regulatory barriers associated with international investing, persistent information asymmetries that favor home-country investors, the perceived increase in downside risk from international exposure, and the fundamental irrationality of real-world investors. The paper concludes by considering how foreign firms with domestic listings partially bridge these gaps, suggesting new directions for resolving the puzzle.
The home bias in investing is defined as the tendency of investors to favor domestic equities — or even equities from their immediate geographic region. The puzzle aspect of home bias is that empirical evidence has supported broader geographic diversification as a means to lower risk and increase returns (Coval & Moskowitz, 1999). The explanations offered for the bias have generally troubled academics, yet they are perfectly reasonable in the real world.
The first explanation for home bias is that international investing is more expensive and time-consuming. Governments have restrictions on foreign stock ownership, transaction fees are higher, and the potential for foreign taxes all create barriers to foreign investment (Coval & Moskowitz, 1999). Outside of institutional investing, these restrictions remain real. However, even retail customers can circumvent these boundaries with international equity funds.
While it has been argued that barriers to capital flows have been reduced, these reductions do not necessarily benefit the retail investor. Investing overseas requires working with a broker who is licensed to operate in that jurisdiction, which can be a costly and time-consuming process. This renders such trading largely the domain of institutional investors — yet home bias remains prevalent among that category of investor as well.
The second set of explanations for home bias lies with information. It has been postulated that in today's information age, all investors should have equal access to information about any company. This argument rings hollow for several reasons.
The first is that information from other jurisdictions does not necessarily conform to a format familiar to investors in a different country, with respect to financial statements, terminology, or the types of disclosures required. Investors face an inherent disadvantage when gathering information on companies that do not conform to the reporting requirements with which they are familiar.
The second is that the information may not be in the investor's language or currency, creating translation error risk. An American investor seeking information on a Japanese company will invariably uncover less useful data than a Japanese investor, strictly due to the language barrier.
The third reason that information is not equal is that investors typically have specific insight into the geographies and industries of their own nation or region. Domestic companies are the topic of community conversation, they are visible, and investors have greater access to people with minor but valuable insights about them. Regional centers of knowledge are clearly evident in global capital markets. For example, the Toronto Stock Exchange specializes in mining issues. While any investor around the world can research annual reports and news clippings about mining companies, in Toronto those companies are the subject of ongoing conversation within the community, and industry players down to the manager level are known personally to local investors. This gives Toronto investors a competitive advantage in mining investing, which is reflected in a home bias toward that sector. As Van Nieuwerburgh and Veldkamp (2007) explain, home investors exhibit bias because they possess information that non-home investors do not. These information asymmetries persist even with today's global information pipelines, and the cost of acquiring equivalent information can be quite high despite the relative speed of its diffusion among global investors.
"Perceived downside risk and irrational investor behavior"
"How foreign listings and new hypotheses address the puzzle"
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