Does familiarity breeds investment? An empirical analysis of foreign equity holdings”, working paper

Traditional financial diversification theory states that one should hold a portfolio with a well diversified mix of assets, both nationally and internationally. Using new international asset holdings data, this paper examines the foreign diversification of more than thirty countries around the world. It confirms the lack of international diversification is still an ongoing phenomenon, but more importantly this article demonstrates that the small diversification that is present is not even well diversified across foreign equity markets. What then affects the diversification that is present? The empirical analysis finds significance in familiarity factors such as a common language, trade and possibly immigrant links, which would support an information-based explanation for equity home bias. Additionally, the results demonstrate that interestingly, other factors such as monetary unions and market trading costs are insignificant. Overall the results help shed some light on foreign diversification and the equity home bias phenomenon