Home Bias in European Countries within a Bayesian Framework

This paper determines to what extent the estimated expect returns on European equity indices will be affected by different degrees of prior confidence in the ICAPM. We also measure how fragile the investors’ prior confidence in ICAPM should be in order to explain the home bias of European pension funds. A Bayesian approach is used to estimate the expected asset returns under different prior scenarios. We show that a moderate mistrust in ICAPM results in estimates of the expected returns, which substantially deviate from the estimates by ICAPM. Furthermore, we find a strong home bias in most countries, which cannot be explained by any degree of disbelief in the ICAPM