Chapter 9: Equity home bias, financial integration, and regulatory reforms: implications for emerging Asia
Since French and Poterba (1991) noted the phenomenon that investors overweight domestic assets in their portfolios, equity home bias has been a topic of major interest for financial economists. Theoretically, gains from international portfolio diversification are substantial. In perfectly integrated international financial markets, where financial assets of similar risks are priced similarly regardless of where they are traded, investors are expected to hold international portfolios and exploit the gains of international portfolio diversification. With the trend of financial liberalization since the 1990s, there has been a considerable reduction in barriers to international portfolio investment. However, earlier studies suggested that equity home bias remains significant (see Lewis 1999; Karolyi and Stulz 2003 for literature review). A significant body of literature has focused on the role of financial openness in lowering equity home bias. In theory, financial openness and integration provide better opportunities for local investors to allocate their portfolios in international equities that yield the highest returns given the same risks. By allowing for portfolio adjustments towards equities that offer higher returns at lower risks, financial integration enables equity home bias to decline.
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