This paper shows that there is a close relation between corporate governance and the portfolios held by investors. Most firms in countries with poor investor protection are controlled by large shareholders, so that only a fraction of the shares issued by firms in these countries can be freely traded and held by portfolio investors. We show that the prevalence of closely-held firms in most countries helps explain why these countries exhibit a home bias in share holdings and why U.S. investors underweight foreign countries in their portfolios. We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders (the world float portfolio). The world float portfolio differs sharply from the world market portfolio. In regression explaining the portfolio weights of U.S. investors, the world float portfolio has a positive significant coefficient but the world market portfolio has no additional explanatory power. This result holds when we control for country characteristics. An analysis of foreign investor holdings at the firm level for Sweden confirms the importance of the float portfolio as a determinant of these holdings.
Introduction: The home bias is the least controversial stylized fact in international finance. There is now much evidence that investors overweight domestic stocks in their common stock portfolios. Excellent data on stock ownership is available for the U.S. for 1997. U.S. investors have roughly 91% of their stock investments in U.S. stocks, but U.S. stocks represent only 49% of the world market portfolio. If investors are mean-variance optimizers in a world of perfect financial markets, they should hold the world market portfolio of common stocks. U.S. investors are not close to holding the world market portfolio of common stocks and neither are investors in other countries.
Author: Magnus Dahlquist,Lee Pinkowitz, René M. Stulz, Rohan Williamson
Source: Institute for Financial Research
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