How to measure the impact of home bias.
The well-known phenomenon of home bias in finance refers to the tendency of investors to prefer investments in domestic securities instead of enjoying the added value of diversification through investments in foreign securities.
Home bias is difficult to measure. This is due to the behavioral aspects that are problematic to quantify.
A research study on measuring home bias
Sercu and Vanpée (2007) tried to produce quantifiable results for home bias. In their research Home Bias in International Equity Portfolios: a Review (2007), Piet Sercu and Rosanne Vanpée of the Katholike Universiteit Leuven examine the existence and development of home bias at an international level.
In their research, Sercu and Vanpée also report on possible theories that could explain home bias, but this was already dealt with in the first chapter of this analysis. Sercu and Vanpée use a very similar method to the majority of research on the subject. They compare each country’s market share with its holdings of domestic securities. The proportional shares of these factors are then used to calculate the degree of home bias as a home bias factor. The data in the research is from the end of 2005, with portfolio holdings collected from the Coordinated Portfolio Investment Survey (CPIS) of the IMF and the respective countries’ market shares from the World Federation of Exchanges (Sercu & Vanpée 2007). Through the research, Sercu and Vanpée highlight the existence of home bias in all countries that were included in the survey, in that all countries hold a strongly biased portfolio towards the home country.
The home bias factor, which represents how home biased each country is towards domestic securities, is a scale from 0-100 where a higher value indicates greater home bias. Through the research, Sercu and Vanpée find that the largest home bias is in Indonesia with a home bias factor of 99.7%, while the Netherlands has the lowest level of home bias at 30.8%.
The results show a pattern where industrialized countries generally have a lower level of home bias compared to developing countries or emerging markets, where home bias is often very high.
This is strongly linked to a high level of home bias existing in the most unstable or risky markets, which also tend to be emerging markets. Through these results, it can be concluded that domestic investors in emerging markets carry a lot of risk as they are heavily invested in the home country and that international investors are not willing to take on this risk, leading to a high level of home bias.