Home Bias in Equity Portfolios: Theory and Evidence for Developed Markets

Abstract

Equity home bias is one of the most important puzzles in international finance. This paper tries to measure the home bias equity based on Warnock (2002). We find strong evidence for the phenomena in nine developed financial markets during 1969-2003. We then test the International Capital Asset Pricing Model (ICAPM) of Adler and Dumas (1983) in order to explain the home bias by inflation hedging. We also test ICAPM of Coen (2001) which includes inflation and human capital. Our findings suggest that these two models are rejected. The lack of international diversification in equity portfolios is still a puzzle in international finance.