As as starting point, consider this table. The first column is a list of countries. The second column shows what share of the total global market for equities is represented by the domestic market in that country. Thus, the Australian stock market by value is 1.8% of the value of all global stock markets. The U.S. stock market by value is 32.6% of the value of all global stock markets. The second column shows the share of investments by people in each country that are in the stocks of their own country. Thus, Australia's stock market is 1.8% of the world total, but people in Australia have 76.1% of their equity investments in the Australian stock market. This is home bias in action.
The third column of the table is a common measure of "equity home bias" or EHB, defined as:
Home bias has been declining over the last few decades in most high-income countries, and some low-income countries, but it remains high. Here are some illustrative figures for home bias in equities, bonds, and bank assets.
But despite the declines in home bias, it remains notably high. Why are people around the world not taking better advantage of the opportunities for global diversification? This puzzle hasn't been fully resolved, but Coeurdacier and Rey discuss the answers that have been proposed. For example:
- People must weigh the benefits of global diversification against the risk of being exposed to fluctuations in exchange rates, and they may not have an easy way to protect themselves against those fluctuations.
- Some people have wage income where they are already somewhat exposed to economic fluctuations in other countries, while other people do not--which will affect how much diversification they can achieve by investing in other countries.
- Many domestic firms already have significant exposure to international markets, and so investing in those firms means that people are more exposed to economic factors in other countries than it might at first appear.
- Benefits of global diversification need to be weighed against the transactions costs of making such investments, which include differences in tax treatments between national and foreign assets or differences in legal frameworks. Some countries have regulations that make the transactions costs of foreign investment deliberately higher.
- Many investors have better information on investments in their own country than on investments in other countries, so the perceive the foreign investments as being riskier.
- Many investors have certain "behavioral" biases like overconfidence or focusing on what is familiar that tend to drive them toward toward investing in home assets, rather than foreign ones.