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Domestic versus international portfolio selection: a statistical examination of the home bias

Gorman, Larry R. and Jorgensen, Bjorn N. (2002) Domestic versus international portfolio selection: a statistical examination of the home bias. Multinational Finance Journal, 6 (3-4). pp. 131-166. ISSN 1069-1879

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Abstract

The observed international home bias has traditionally been viewed as an anomaly. This paper provides statistical evidence contrary to this view within a mean-variance framework. Two methods of estimating the expected return and covariance parameters are investigated: (i) the traditional Markowitz approach, and (ii) the Bayes-Stein "shrinkage" algorithm. In-sample tests reveal that neither the Markowitz tangency allocation vectors nor the Bayes-Stein tangency allocation vectors are significantly different than a 100% domestic allocation (i.e. extreme home bias). These results are robust to the shorting of equity and across foreign exchange hedge strategies. The paper also reports out-of-sample tests with a view toward investment performance. Typically, a 100% domestic allocation outperforms both the Bayes-Stein and Markowitz tangency portfolios. Overall, the theorized gains to international diversification appear difficult to capture in practice and, hence, investors exhibiting a strong home bias are not necessarily acting irrationally.

Item Type: Article
Official URL: http://www.mfsociety.org/page.php?pageID=162
Additional Information: © 2002 Multinational Finance Society
Divisions: Accounting
Subjects: H Social Sciences > HG Finance
JEL classification: F - International Economics > F3 - International Finance
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
Date Deposited: 28 Aug 2013 09:08
Last Modified: 15 Sep 2023 12:49
URI: http://eprints.lse.ac.uk/id/eprint/52122

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