An Empirical Validation of a Home Bias Model
To study world equity markets indices and their corresponding relationship with a portfolio consisting of U.S. MNCs, we conducted correlation, cointegration and bivariate Granger causality tests. Using daily returns of the past five years, we have concluded that the inclusion of foreign equities increases returns of a diversified home portfolio. From the cointegration tests, we concluded that there is no long-term equilibrium relationship between the U.S. indices and the selected foreign indices. Finally, correlation tests led us to conclude that U.S. MNCs do not follow foreign indices in terms of returns. In summary, our empirical analysis suggests that U.S. investors should diversify their portfolios by including home equities traded abroad selected in developed and emerging markets. This result corroborates that of Salehizadeh (2003). Since U.S. MNCs could not substitute indices returns, home bias problem will continue to exist because, on the one hand, foreign investment has risks that are absent in home portfolios and on the other hand, U.S. institutional investors have an information advantage as well as higher international returns.
