Why do investors exhibit home-country bias and how do I quantify it?

Question

AcadiFi · Accepted Answer

**Measurement**: Home-country bias = (domestic allocation − domestic share of global market cap) / domestic share of global market cap. US represents ~60% of MSCI ACWI. If a US investor holds 88% in US equities, bias = (88% − 60%) / 60% = +47% overweight domestic.

**Drivers of home bias**:
1. **Familiarity** — investors overweight what they know; Kauai Regional Pension holds 90% US stocks because managers cover US names.
2. **Transaction and information costs** — foreign tax reclaim friction, custody fees, research gaps on mid-cap foreign names.
3. **Currency risk perception** — investors penalize volatility introduced by unhedged FX.
4. **Liability matching** — pension funds with USD liabilities rationally prefer USD-denominated assets.
5. **Regulatory and tax preferences** — 401(k) default options, qualified dividend tax treatment on US stocks.
6. **Behavioral** — optimism about home country, patriotism, media coverage.

Worked example: Takeshi at Marinebridge Capital reviews his firm's 2026 asset allocation. Portfolio is 78% US / 22% international. Global market cap weights: 60% US / 40% ex-US. Home bias = (78% − 60%) / 60% = +30%. Even accounting for USD liability matching (+5% overweight), the residual ~25% reflects behavioral and information-cost factors.

**Consequences**: Missed diversification, concentration risk in domestic macro shocks, and reduced exposure to faster-growing emerging markets.

**Partial rationality**: Some home bias is economically justified — liability matching, withholding tax drag on foreign dividends (15–30%), higher transaction costs. But most empirical work finds bias FAR exceeds rational levels.

CFA exam often tests the formula and the distinction between rational vs behavioral home bias.

Why do investors exhibit home-country bias and how do I quantify it?

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