Question

Read the following case:

Global Investments Are Still a Good Bet

Investors in global equity markets have traditionally hedged their bets, casting their investments far and wide across the world. That way, if the market in one country or region stagnated (think Japan in the 1990s or Europe in the 2000s), they could make up the difference in other sectors that are booming.

However, as markets in different countries have increasingly moved in tandem or correlated, from 50 or 60 percent in the 1990s to more than 90 percent after the financial crisis of 2008, that strategy has seemed less and less worthwhile.

“The claim is that it makes less sense to be diversified than it used to be in the past, since, at the end of the day, all markets are moving together,” says Luis Viceira, George E. Bates Professor and Senior Associate Dean for International Development at Harvard Business School.

All things being equal, that means instead of spreading the wealth around, investors should put their money in places that are familiar—usually their own country. “There is a very well-known phenomenon called home bias,” continues Viceira. “People think they know their own stock market and feel more comfortable investing in it, and they overestimate the risks of investing abroad.”

Required: Is there any disadvantage of being affected by Home Bias? Discuss with reasoning.

Answer 1

Disadvantages of being affected by Home bias:

Mostly investments are subject to risk.Diversification also does not ensure profit or protect against loss.Foreign investments involves additional risk including currency fluctuations and political uncertainty.Past performance does not guarantee future results.

Factors contributing to home bias:

●Expectations about home country markets that they provide better results

●A preference for the familiar risk -return trade off

●Corporate governance practices of home companies

●Liability hedging by domestic investors

●Multi national companies interconnection and growth of foreign companies in domestic market helpful to investors

●Volatility of Foreign currency fluctuations.

The main source of home bias is perception of knowledge local investors regarding local corporations.This behavioural bias is through the investors exposure to advertisements in local news sources.Another factor is lack of knowledge about international investment opportunities

Investors aware of home bias can make changes in portfolio to take advantage of different markets.This exposure to different markets helps to reduce home market risk and get avail of different options for diversification.

Investors mainly thinks about the additional transaction costs and legal restrictions associated with foreign investment.So they are not prioritizing to invest.Foreign market is less closely related with domestic markets so investors not tend to prefer foreign securities.As seen the statistics given it is clearly defined that investors well-known and feel comfortable in domestic investment rather than foreign because of risk factor.These are the factors that affect home bias for domestic investors.