Equity Home Bias and the Euro

Transcription

1 Equy Home Bas and e Euo Hsam S. Foad San Dego Sae Unvesy May, 2008 Absac Ts pape examnes explanaons o e equy ome bas puzzle by ulzng e noducon o e euo n 999 as a naual expemen. Te noducon o e euo and e coodnaon o moneay polcy acoss e Euo Aea EA allows o a close examnaon o s puzzle. Opmal oegn equy saes ae deved om a veson o e CAP-M and en empcally esed usng dealed daa om e MF s Coodnaed Poolo nvesmen Suvey coveng e oegn equy oldngs o 23 counes o e yeas 997 and Wle equy ome bas as allen woldwde ove s peod, by a e sapes dop as been o na-ea equy oldngs w ome bas allng om 68% o 29% beween e pe and pos-euo peods. Seveal explanaons o s dop ae esed, w e educon n nomaon asymmees emegng as e mos pomsng canddae. *Te auo would lke o ank Bob Cnko, Elena Pesaveno, Sean Kause, Zeng Lu, and pacpans a e 2005 SEA Coneence o e nvaluable commens and asssance on s poec. Please dec all nques o e auo a oad@mal.sdsu.edu o o e ollowng malng addess: Depamen o Economcs, San Dego Sae Unvesy, 5500 Campanle D., San Dego, CA 9282.

2 . noducon Wy do nvesos old so muc o e weal n domesc equy wen empcal evdence ndcaes bo ge euns and lowe sk oug nceased nenaonal dvescaon? An nluenal sudy by Fenc and Poeba 99 glged s puzzle, ndng a o aonalze e dea o nenaonal dvescaon among nvesos, expeced euns on ome-couny equy would ave o be seveal unded bass pons geae an ose n oegn makes, an expecaon a om ealy. To pu equy ome bas n pespecve, consde consumpon smoong. n a closed economy, consumpon s enely deemned by oupu. You consume ee ou o you ncome o om you savngs, wc ae bo uncons o domesc oupu. oupu alls, so oo does consumpon. n an open economy, ee s an oppouny o dvesy consumpon sk acoss bodes. By oldng oegn equy, you consumpon wll depend no only on you own couny s oupu, bu also on e oupu o all oegn counes wose equy you old. n a complee make, consumpon sk wll be equally saed acoss counes and we sould obseve consumpon gow aes equalze acoss counes snce eveyone can dvesy consumpon sk nenaonally. Wle eoecally sound, s agumen as no eld up empcally, wa Lews 999 ees o as Consumpon Home Bas. To llusae, Table sows consumpon and oupu gow ae coelaons ove e peod o e G-7 counes. Consumpon coelaons ae no sgncanly deen an oupu coelaons, an obsevaon a odds w e concep o consumpon sk dvescaon. Tus, oppounes o lowe sk n bo savngs and n consumpon ae no beng exploed. Has e omaon o e Euo Aea EA ad any eec on ome bas? examne s ssue n e conex o ow e adopon o a common cuency and moneay polcy as nluenced e popula explanaons o equy ome bas. One pomnen explanaon s a oegn equy caes addonal excange ae sk. Wn e EA, e adopon o a common cuency elmnaes nomnal sk, loweng one o e poenal baes o nenaonal dvescaon. Anoe posed explanaon s a domesc equy seves as a supeo nlaon edge. A common moneay polcy acoss e EA, sould lead o geae pce convegence, educng e compaave advanage o domesc equy as an nlaon edge. Te mos successul explanaon o equy ome bas us a s a nvesos only ave lmed nomaon on oegn equy, causng em o nves n wa ey know. As e omaon o Fenc and Poeba esmae e domesc equy sae o e oal equy poolo a 79% n Gemany, 89.4% n Fance, 92% n e UK, 92.2% n e U.S., and 95.7% n Japan. 2

3 e EA sould lead o nceased coss-bode ade and nvesmen, nomaon lows beween EA membes sould also ncease. Eecvely, e EA as educed e economc sgncance o naonal bodes beween membe saes. Sould we eeoe expec o see geae coss-bode equy oldngs wn s aea? Ts s pecsely e esul nd ee. Po o 999, na-ea equy oldngs dsplay a 32.3% coelaon w e opmal poolo suggesed by e nenaonal capal asse pcng model CAPM. Ae e omaon o e EA, na-ea oldngs dsplay a 7.0% coelaon w s opmal poolo. Wle s ue a ome bases ave declned woldwde ove s peod, by e declnes acoss e EA ave been an ode o magnude lage. Ts sudy pesens compellng evdence a e adopon o a common cuency as lead o sgncan nceases n poolo dvescaon acoss e EA. Seveal ecen sudes ave examned s ssue and ound a smla esul. De Sans 2006 nds a beween 998 and 200, e noducon o e euo led o nceased poolo lows o $22-47 bllon n eques and $32-76 bllon n bonds. He agues a wle some o s can be abued o educed ansacon coss o a common cuency, e megng o e Amsedam, Bussels, and Pas sock excanges no Euonex suely played a ole. De Sans and Gead 2006, usng a deen meodology, also nd evdence o e euo educng ome bas. My pape bulds upon e exsng leaue n seveal ways. Fs, my pos-999 sample coves e peod By ncludng a longe pos-euo peod, ee s less o a cance a some dosyncac caacescs o 200 e yea used n bo papes dscussed above ae beng msnepeed as euo eecs. Second, s sudy beaks down equy oldngs no ou dsnc goups based on a couny s membesp n e EA. Dong so allows o bee dencaon o e eecs o e euo. Fnally, weeas e wo pevous sudes ocused on moneay aspecs o a sngle cuency, my pape ocuses on ow e omaon o a sngle cuency aea nceases nomaon lows oug songe ade lnkages. 2. Ae ee Gans om nenaonal Dvescaon? Te welae loss assocaed w nvesos peeences o domesc equy depends on e oppouny cos o equy ome bas. Wa ae nvesos mssng ou on by no nceasng oegn equy exposue? One way o assess e poenal gans om nenaonal dvescaon s oug mean-vaance analyss. Ts meod allows us o examne e bo e sk and eun on deen equy poolos, compang a puely domesc equy poolo o ones w nceasng saes o oegn equy. As s sudy ocuses on e eecs o e euo on equy 3

4 ome bas, e analyss n s secon wll ocus on nenaonal dvescaon om e pespecve o wo nvesos: one locaed n e UK and anoe n Gemany. Fo e UK nveso, e mean-vaance analyss s consuced by akng e aveage monly euns on bo e MSC UK ndex and e MSC Euope excludng e UK ndex. 2 A sees o 2 poolos angng om 00% UK equy 0% Euopean o 0% UK 00% Euopean equy ae consuced n nceasng ncemens o 5% Euopean equy. Fgues a and b plo e aveage monly eun and monly sandad devaon o eac o ese equy poolos acoss e me peods pe-euo and pos-euo especvely. Lookng a Fgue a, we see a po o e noducon o e euo, all poolos w geae an 50% UK equy ae scly domnaed by poolos w geae oegn equy.e. ave bo lowe euns and ge sk. 3 Te opmal poolo seleced by a ypoecal Bs nveso wll depend on e oleance o sk, w e sae o Euopean equy nceasng w sk oleance. Te key pon, oweve, s a even e mos sk avese Bs nveso sould ave only eld 50% domesc equy n e pe-euo peod, a sae a smalle an wa Bs nvesos acually eld. 4 Dd e gans om nenaonal dvescaon cange o Bs nvesos ae e noducon o e euo? Fgue b pesens evdence a ee eman gans, oug a lage domesc equy sae may be used. n e pos-euo peod, e poolo composed enely o Bs equy acually eans a negave eun. s oweve, e poolo w e lowes sk. we assume a nvesos a leas wan a posve eun, en ey sould neve ave moe an 60% Bs equy n e poolo, agan ge an e obseved sae e UK domesc equy sae n 2002 was 73%. Fgues 2a and 2b pan an even sake pcue. n ese gaps, e aveage eun and vaance o a ange o poolos o e ypcal Geman nveso ae ploed. Te poolos ange om 00% Geman equy o 00% Euo Aea equy. Smlaly o e Euope excludng e UK poolo, e compose Euo Aea poolo s consuced as a make capalzaon weged aveage o e MSC ndexes o e Euo Aea counes excludng Gemany. Fgue 2a llusaes a a poolo composed o 95% Euo Aea equy scly domnaes any poolo 2 Te MSC Euope ex. UK ndex s a weged aveage o e MSC couny ndexes o 5 Euopean counes, wee e wegs ae deemned by eac couny s sae o oal Euopean make capalzaon. 3 Te em oegn equy ee means Euopean equy. Clealy, UK nvesos could dvesy no non- Euopean makes suc as e US. Te empcal meodology wll accoun o uly global dvescaon. 4 Fenc and Poeba 99 esmae e sae o domesc equy n e Bs nveso s poolo o be 92%. n 997, esmae a e domesc equy sae o e UK s 79%. n bo cases, e obseved poolo sae s scly domnaed n e mean-vaance analyss by a smalle domesc equy sae. 4

5 conanng moe an 5% Geman equy. Assumng zeo ansacons coss beween makes and complee nomaon, s esul mples a Geman nvesos sould be nealy compleely dvesed nenaonally. Ae e noducon o e euo Fgue 2b e poolo w zeo Geman equy domnaes all oes. Te key pon s a ee ae ndeed gans o be made, even by dvesyng sk acoss e EA Explanaons o Home Bas Gven e song ncenve o nvesos o dvesy e weal poolos acoss bodes, wy do ey no do so? Vaous explanaons o e ome bas puzzle ave been oeed w vayng empcal success. Te man explanaons o ome bas ae:. Tansacons coss lm oegn equy ownesp 2. Domesc asses povde a supeo edge agans nlaon 3. Foegn eques cay addonal excange ae sk 4. nenaonal dvescaon can be ndecly aceved by nvesng n mulnaonals 5. Lmed nomaon abou oegn equy causes nvesos o sck w wa ey know n e domesc equy make. Explanaons o ome bas can be pu no pespecve by examnng a eoecal model deved by Mcaeldes n e pesence o lqudy consans and undvesable labo ncome sk, any posve coelaon beween domesc asse euns and ncome socks may lead o poolos compleely composed o oegn equy consumpon smoong. Howeve, equy ome bas may acually be used as opmal beavo n e pesence o make mpeecons suc as ansacon coss, pemums on domesc asses, o excange ae sk. Wle eoecally appealng, explanaons o ome bas ave no peomed well n empcal ess. Te agumen a ansacons coss lm oegn equy ownesp s songly eued by Tesa and Wene 995, wo nd a e unove ae on oegn equy s muc ge an a on domesc equy, a esul suggesng lowe ansacons coss. On e oe and, Amad and Begn 2006 ague a wle unove aes ae g o nvesos wo ave aleady aken e plunge no oegn makes, ey gnoe e poenally g xed coss o oegn make eny. Tese xed coss peven a subse o nvesos om any nenaonal dvescaon. Coope and Kaplans 994 examne e supeoy o domesc equy as an nlaon edge and nd a wle domesc equy does peom well n s egad, s alone s 5 Wle no depced, a smla analyss eveals gans o be made o e oe EA naons as well, oug no que as damac as ose o Geman nvesos. 5

6 no enoug o usy e mssed gans om nenaonal dvescaon unless nvesos ae sgncanly moe sk avese an wa as been empcally measued. Excange ae volaly clealy adds an exa elemen o sk o nenaonal dvescaon. Fdoa, Fazsce, and Tmann 2006 look a e mpac o eal excange ae volaly on equy ome bas. Tey nd a cuency sk s o seconday mpoance, avng only ponounced eecs o asses w low volaly n local cuency euns. Te sudy suggess a e elmnaon o excange ae volaly would educe ome bas n bonds low eun volaly by 60%, bu only educe ome bas n eques g eun volaly by 20%. Cuency sk maes, bu alone canno explan e obseved massve ome bases n eques. Can nvesos aceve nenaonal dvescaon ndecly oug mulnaonals? Ealy wok by Jacqulla and Solnk 978 demonsaed a s cannel canno povde muc dvescaon, ndng a only 2% o e vaance n US mulnaonal equy euns can be abued o e oegn makes ey opeae n. Moe ecen evdence s gven by Rowland and Tesa 998 and Ca and Wanock n bo sudes, nvesng n mulnaonals does povde some nenaonal dvescaon, elecng e expanson o mulnaonal acvy ove e pas 20 yeas, bu ee ae sll sgncan gans o be made om dec dvescaon. One explanaon a as ad some empcal success s e exsence o nomaonal asymmees beween domesc and oegn asses. Wle Jeske 200 nds a nomaon asymmees alone canno explan away e puzzle, numeous sudes ave ound a asymmec nomaon s a ccal consdeaon. Coval and Moskowz 999 nd a even wn e same couny, ome bas exss. Macng e locaon o a muual und manage w e eadquaes o e ms eld by e und, e auos nd a manages exb a song peeence o locally eadquaeed ms. Song and Xu 2003 appoac s ssue w suvey daa, ndng a muual und manages n e US, UK, connenal Euope, and Japan all dsplay sgncan opmsm owad e peomances o e ome couny makes. Fauqee, L, and Yan 2004 esmae an augmened gavy model o equy oldngs and nd a one o e vaables a peoms emakably well s nomaon asymmey as poxed o by dsance. Poes and Rey 2005 poxy nomaon asymmees w elepone ac beween counes, oegn bank bances n a couny, and e numbe ovelap ous n equy adng makes. All o ese vaables pove o sgncanly aec blaeal equy lows. Babe and Odean 2005 povde moe evdence o e nomaon agumen, ndng a nsuonal nvesos end o ade n only a small subse o eques, geneally ose ey aleady own. Fellne and Maceovsky 2003 use expemenal meods o nd a socal dencaon w an equy can lead o domescally based poolos. Gnbla and Keloau 200 nd a ese nomaon 6

7 asymmees may be pesen, even beween negbong and aly culually smla naons, w Fnns nvesos dsplayng a song peeence o Fnns ms ove Sweds ms and vce vesa. W e asymmec nomaon agumen, aen we us eplacng e puzzle o capal mmobly acoss bodes w one o nomaon mmobly? e euns o geae nenaonal dvescaon ae so lage, en wy aen nvesos beakng down nomaon baes? Ts s e agumen made by Van Neuwebug and Veldkamp Tey ague a nvesos ave a compaave advanage n pocessng nomaon abou local asses and maxmze s advanage by nvesng n local asses. s no a nomaon s mmoble acoss bodes, bu a nvesos puposeully and peaps aonally coose o gnoe. n ee case, equy ome bas esuls om domesc nvesos avng deen nomaon ses an oegn nvesos wee by ndvdual coce o by make mpeecon. How as e adopon o a common cuency and a sngle moneay polcy acoss e EA aeced equy ome bas? To answe s queson, we mus look a ow e euo as aeced e ve explanaons o ome bas oulned above. Te megng o e Amsedam, Bussels, and Pas sock excanges no Euonex ceanly educed vaable ansacon coss. Te adopon o a common cuency may also educe xed eny coss. Fo example, seng up an opmal excange ae edgng saegy pevened some nvesos om eneng oegn makes beoe, s bae s elmnaed w e adopon o a common cuency. Smlaly, e addonal nomnal excange ae sk caed by oegn asses s elmnaed wn e EA, loweng one o e coss o nenaonal dvescaon. Te pesence o a common moneay polcy and nceased ade wn e unon sould lead o pce convegence. As a esul, e supeoy o domesc asses as an nlaon edge s educed. Fnally, geae economc negaon sould lead o moe nomaon lows acoss bodes, educng asymmec nomaon o nomaon advanages beween domesc and oegn equy. Teeoe, we sould expec equy ome bas wn e EA o all ae e noducon o e euo. Tese agumens depend on ee sll beng a movaon o dvesy na-ea. equy makes wn e EA ae peecly coelaed, en ee s no ncenve o dvesy. Fankel and Rose 998 ague a e nceased coodnaon o busness cycles necessay o an opmal cuency unon s sel a sel-ulllng popecy. Do nceased oupu coelaons lead o geae equy make coelaons? Seveal sudes ave examned s ssue and wle appeas a equy makes ave become moe synconzed snce 999, s esul s gly dependen on e sample peod beng suded. Rouwenos 998 looks a equy make coelaons om e convegence peod o e EA and nds lle evdence a coelaons nceased 7

8 dung s peod. Hadouvels, Mallaopulos, and Pesly 200 allow o a me-vayng degee o negaon and nd a e equy makes a ae e mos negaed ove s peod ae ose a ave e smalles owad nees ae deenals w Gemany, as ese makes wee peceved o be e ones mos lkely o adop e euo. Adaoue and Danne 2000 conm e ncease n EA equy make coelaons usng Box and Jenc ess o e sably o e na-ea eun coelaon max. n a lae pape a exends e sample oug md- 200, oweve, Adaoue and Danne 200 nd a n ac, eun coelaons ave allen. Tey ague a e conlcng esuls may be due o a cyclcal end n equy make coelaons, and leng ou e end would eveal a long-un ncease n EA coelaons. Te cenal queson asked by s sudy s wee o no a common cuency educes equy ome bas. n ac equy make coelaons ave nceased snce e noducon o e euo, en e ncenve o dvesy acoss e EA s educed. n s case, any evdence a ome bas ell ollowng e adopon o e euo s lkely o be a lowe bound esmae o ow a common cuency can ncease dvescaon oug elmnang cuency sk and nceasng nomaon lows. 4. Te Opmal Sae o Foegn Equy n s secon, a smpled veson o e CAPM s used o consuc a model n wc e adopon o a common cuency aecs e sae o oegn equy eld n domesc poolos. Usng e amewok n Lews 999, assume a ee ae wo counes n e wold: ome and oegn. Fom e pon o vew o a ome nveso, e sae o oegn equy n e weal poolo s gven by χ and e sae o domesc equy s χ. Te nveso s uly s nceasng n expeced weal, bu deceasng n e vaance o weal. He obecve uncon s gven by: E W ], Va[ W ] U U [ U U w > 0 and < 0 E[ W ] Va[ W ] W s e nveso s eal weal a me, s e ome nveso s nomaon se a me, wle E[ ] and Va[ ] ae e expecaons and vaance opeaos especvely. Wou loss o genealy, assume a e nveso s weal s composed enely o e value o e poolo. Unde s assumpon, we may deve e ollowng expessons: E[ ] E[ ] E [ W ] W χ χ 2 8

9 , Cov W Va W Va W W Va χ χ χ χ 3 Dene eal euns as, wee e supescp ees o e asse s couny o ogn e.g. an equy ssued by a m locaed n couny Te eal eun on an asse s a uncon o s nomnal eun R, nlaon n e nveso s ome couny π, and e nomnal excange ae expessed n uns o oegn cuency pe ome cuency s. Te eal euns on vaous asses ae gven by: Home nveso: s R R π π 4 Foegn nveso: R s R * * * * π π Home nvesos ave lmed nomaon abou oegn asses and oegn nvesos ave lmed nomaon on ome asses. Assume a e eun on a oegn asse s pedced w a geae degee o unceany by a ome nveso an one lvng n e oegn couny: η η 0, ~ ; * Va Va E u E E E u u 5 Bo ome and oegn nvesos om e same expecaon abou e oegn equy, bu e oegn nvesos ae able o om s pedcon w geae ceany an e ome nveso due o asymmec nomaon. Fo symmey, noe a: η η 0, ~ ; * * * * * * Va Va E u E E E u u 6 Te ome couny asse s pedced w geae eo by oegn nvesos due o e lmed nomaon se compaed o ome couny nvesos. To deemne opmal poolo saes, e nveso wll maxmze e obecve uncon gven by w espec o, subsung n e denons gven by 2, 3, and 5. Te esulng s ode condon s: χ 0 ] [ ] [ ] [ ] [ W Va W Va U E W E W U U χ χ χ 7 Assumng a uly uncon w consan elave sk aveson, equaon 7 can be expessed as: 9

10 E[ W 2W * Va[ W ]/ χ ]/ χ γ 8 U / Va[ W ] Wee γ 2W * s e coecen o elave sk aveson. Usng ese U / E[ W ] condons, e opmal sae o oegn equy s gven by: 6 χ γ / E E Va Cov, 9 Va η Va η Te opmal oegn equy sae s a uncon o e expeced excess eun o oegn equy, e degee o sk aveson, e vaably o ome euns, e coelaon beween ome and oegn euns, e volaly o excess oegn euns, and e added unceany due o asymmec nomaon. Te s em s aly sagowad, sang a nvesos sould ncease e oegn equy exposue oegn equy s expeced o oupeom domesc equy. Ts s empeed, oweve, by e nveso s sk oleance. Te geae e nveso s sk aveson, e lowe e weg se places on equy peomance. Te second addve em deals w elave unceany n ome and oegn equy, wa Lews 999 ees o as e poolo sae a mnmzes e vaance o e weal poolo. Le us ewe 9 o gve an ease nepeaon: χ 2 E γ σ ρ σ E / Va η Va η σ 9 Te sandad devaons o ome and oegn equy euns ae gven by σ and σ, wle e coelaon beween ome and oegn euns s ρ. As ome euns become moe volale elave o oegn euns, e opmal sae o oegn equy ses. Ts dynamc s mgaed, oweve, by e coelaon beween ome and oegn euns. n e exeme case wee e euns ae peecly posvely coelaed, en ee s no dvescaon bene om oegn euns and nvesos only cae abou e expeced eun deenal. Wen ome and oegn euns ae peecly negavely coelaed, oegn euns ae peec o dvescaon and e opmal sae nceases w e volaly o bo ome and oegn euns. Fnally, zeo coelaon beween euns mples a e sk ncenve o dvesy no oegn equy s enely deemned by e volaly o ome euns. Eac o e addve ems n e numeao s delaed by bo e vaance o excess oegn euns and e pedcon eo due o 6 Noe a we ave dopped e condonal noaon o ease o exposon. Tougou e pape, assume a all expecaons ae omed usng nomaon avalable o e nveso a me. 0

11 asymmec nomaon. Wen excess oegn euns ae moe volale, nvesos educe e oegn asse poson. Te same s ue wen nomaon abou oegn makes s lmed. How s e opmal sae o oegn equy aeced wn a cuency unon? To examne s ssue, we mus s deconsuc e opmal oegn equy sae 9 no nomnal euns, nlaon, and excange aes, e componens o eal euns. Ou analyss wll be smpled by makng wo assumpons:. Expeced nlaon s bul no e nomnal euns o all asses. Tus e eal eun s a uncon o unancpaed nlaon, wc as an expeced value o zeo: Eπ Nomnal excange ae movemens canno be pedced, makng e expeced cange n e nomnal excange ae equal o zeo: Es 0. 7 Usng ese assumpons, we can deve e ollowng esuls o e vaance and covaance o ome and oegn asse euns: Va Va R Va π 2Cov R, π 0a Va Va R Va π Va s 2Cov R, π 2Cov R, s 2Cov π, s 0b Cov, Cov R Cov π, s Va π, R Cov R, π Cov R, π Cov R, s 0c χ Subsung 0a-0c no 9 yelds: E E γ, / Va R Cov R R Va η Va η Cov R Va R, π Cov, s η Va η Te second addve em n s expesson s analogous o e second em n equaon 9, only usng nomnal as opposed o eal euns. Te d em s an nlaon edge em. oegn excess euns ae gly coelaed w nlaon, en oegn equy seves as an eecve edge agans nlaon., on e oe and, domesc equy euns end o ncease moe w nlaon, en s em wll cause e opmal oegn sae o all. Te ou em capues e depecaon sk o oegn equy. As e nomnal excange ae ses, e eal eun on oegn equy alls. domesc euns and e nomnal excange ae e gly coelaed, s moe lkely a domesc eal euns wll oupeom oegn eal euns. 7 Valdaon o s assumpon can be ound n e empcal success o e andom walk model o excange aes. excange aes ollow a andom walk, e bes pedcon o e excange ae omoow s e excange ae oday, makng e expeced cange n excange aes equal o zeo.

12 Ts las em addessed e co-movemen beween domesc euns and e excange ae, bu wa abou sandalone excange ae sk? To assess s, le us decompose e common denomnao n. W some manpulaon, s can be e-wen as: Va Va R R Va s 2Cov R R, s 2 Tus, any ncease n excange ae volaly wll cause 2 o ncease, n un loweng e opmal sae o oegn equy. To summaze ese elaons, we dene and sgn e opmal oegn equy sae as: χ E, E, γ, Va R, Cov R, R, Cov R R, π, Cov, s, Va s 3 Wa eec, any, wll e omaon o e EA ave on e opmal sae o oegn equy n a weal poolo? To answe s queson, we mus see ow e omaon o e EA aeced e deemnans o opmal oegn oldngs gven n 3. We can dvde e mpac o e EA no ou caegoes o oegn equy oldngs:. Te sae o oegn EA equy n a domesc EA poolo 2. Te sae o oegn non-ea equy n a domesc EA poolo 3. Te sae o oegn EA equy n a domesc non-ea poolo 4. Te sae o oegn non-ea equy n a domesc non-ea poolo. An example o case would be e sae o Fenc equy n a Geman nveso s poolo, wle case 2 would be e sae o Bs equy eld by e Geman nveso. Case 3 could epesen e sae o Geman equy n a Bs nveso s poolo, wle case 4 could be e sae o Sweds equy eld by e Bs nveso. Fs examne case. Tee s no a po eason o beleve a e EA as undamenally canged expeced asse euns acoss e unon, nvesos sk oleance, o e dosyncac vaance o nomnal euns. Wn e EA, e coelaon beween equy euns as nceased w economc negaon, mplyng a na-ea oegn oldngs sould all. Howeve, s same pocess o economc negaon sould educe asymmec nomaon wn e EA, nceasng e opmal oegn equy sae. Te elmnaon o mulple cuences causes nomnal excange ae volaly o all o zeo, agan nceasng e opmal 2

13 oegn sae. 8 Fuemoe, e coodnaon o moneay polcy acoss e unon sould lead o a amonzaon o nlaon aes, educng e compaave advanage o domesc equy as an nlaon edge. Summazng e above dscusson: Cov R, R Te EA educes χ : > 0 EA Cov R R, π Va s η Te EA nceases χ : > 0, < 0, < 0 EA EA EA Wee o no e omaon o e EA causes equy oldngs acoss e cuency unon o ncease wll depend on wc se o eecs domnaes. makes ave become so gly coelaed a e benes o dvescaon ae wased ou, en na-ea oldngs sould all. ee ae sll benes o dvesyng na-ea, en educed sk on oegn equy boug abou by e adopon o a sngle cuency and coodnaed moneay polcy sould lead o geae equy oldngs acoss e cuency unon. s dcul o make smla pedcon egadng cases 2-4, as muc wll depend on ow non-ea makes esponded o e omaon o e EA. Te es o e pape empcally esmaes ese eecs. 5. Te Daa Domesc oldngs o oegn equy ae obaned om e MF s Coodnaed Poolo nvesmen Suvey CPS. Te MF s nsued s suvey n 997 n esponse o global nconssences n balance o paymens daa, especally n poolo nvesmen lows. Tweny-seven counes pacpaed n e 997 sudy, w coveage nceasng o ove 60 counes n e annual suveys begnnng n 200. Te oegn equy oldngs o 23 epong counes a old asses ssued by 43 pane counes o e yeas 997 and ae sampled. Only ose naons a ave sgncan oegn equy oldngs spead ove a aly wde ange o counes wee seleced as epoes. Te 43 pane counes wee seleced on e bass o make capalzaon, epesenng e mos lkely desnaons o oegn capal. Te CPS daase and make capalzaon daa ae used o consuc equy poolos o eac epoe couny. Te epoe s equy poolo s dened as e oal value o domesc equy as measued by make capalzaon less ose eld by oegnes plus e oal value o oegn asses eld a ome. Tese poolos ae compued as: 8 Ts wll also cause e covaance beween eal domesc euns and e nomnal excange ae o all o zeo, nceasng e opmal oegn sae. 3

14 K K D M e e,, 4 Fo example, e equy poolo o epoe s equal o e oal make capalzaon n couny M, less e oal value o couny equy eld by oegn counes e 2, e 3, e K,, plus e oal value o oegn equy eld by couny e,2 e,3 e,k. Te sae o a pacula oegn couny s equy n e epoe s poolo s gven by: χ e / D 5, Wle e oal sae o oegn equy n e epoe s poolo s gven by: K e, χ D 6 Foegn equy saes can us be expessed n ems o a pacula oegn couny o acoss all oegn counes as as been e case n e exsng leaue. Te added lexbly o s appoac s one o e key conbuons o s sudy. Summay sascs on oegn equy oldngs ae gven n Table 2. As can be seen, nealy all e epoe counes n e sample ave equy poolos eavly weged owads domesc asses. As an llusaon, compae eac couny s domesc equy sae w a couny s sae o wold make capalzaon. Assumng unom sk beween domesc and oegn equy, zeo ansacon coss, and peec nomaon, a couny s sae o wold make cap sould mac e domesc equy sae. Te deence beween e weg a couny places on s own equy and a mpled by s sae o wold make cap can be oug o as a oug esmae o ome bas. Te summay sascs n Table 2 ndcae sgncan ome bas acoss Euope and e es o e wold. Aloug s ypoess wll be omally esed lae n e nex secon, s useul o look a ow oegn equy oldngs ave canged acoss counes ove me. n pacula, dd e omaon o e EA n 999 ave any mpac on ome bas? Table 2 spls e epoe counes n e sample no ee goups: EA Membes, Non-EA Euope, and Non-Euope. Fo eac egon, e aveage domesc equy sae and e egon s oal sae o wold make cap s compued. To ge a sense o e ome bas n eac egon, e ao o domesc equy sae o wold make cap sae o eac egon s compued. n 997, s ao s equal beween EA membes and non-ea Euopean counes. Conas s w e pos-999 peod and we see a sap dop n ome bas o e EA membes w lle cange o e non-ea naons. Wle seemng o conm e eoecal pedcons om e las secon, we mus be cauous as muc o s esul s dven by eland s so poson n domesc equy. Omng s case educes, 4

15 bu does no enely elmnae, e deence beween EA and non-ea counes ae 999. Fomally esng e mpac o e euo on equy ome bas wll be e ocus o e es o e pape. 6. Equy Home Bas and e Euo pucasng powe pay olds and nancal makes ae globally negaed, en e CAPM pedcs a all nvesos sould old poolos w naonal wegs equal o eac couny s sae o wold make capalzaon. 9 Te exsng leaue as commonly measued ome bas by compang e acual sae o domesc equy n a couny s weal poolo o a couny s sae o wold make capalzaon. Home bas s esed by esmang e ollowng elaon: χ 7, β M, / M Z,, Γ u,, Te oegn equy sae eld by couny s egessed on e oegn couny s couny sae o wold make capalzaon and a veco o domesc and oegn couny specc conol vaables Z,,. A lbeal denon o ome bas would be o esmae β and see ow close s o uny. nvesos n couny ae uly ollowng e global poolo, en a % ncease n couny s sae o wold make capalzaon sould nduce a % ncease n couny s oldngs o oegn equy. Any esmae less an suggess a bas agans oegn equy elave o e global nveso and any esmae geae an suggess a bas n avo o oegn equy. Noe a s s a lbeal denon o ome bas snce does no eque nvesos o acually old wegs equal o e make poolo, only o adus e poson n andem w e poolo. Home bases esmaed usng s meod ae lkely o be lowe bounds, snce ey allow o absolue devaons om e global poolo, only equng a local poolo wegs ae coelaed w global wegs. Ts agumen pesupposes a e opmal sae o domesc equy s gven by e couny s sae o wold make capalzaon. Wle s s a vey song assumpon, we can poceed w e es we ae able o conol o easons wy e wold make cap sae would no be opmal. We do s by ncludng n e egesson e vaables deved n equaon 3: χ, β M, / M β 2E β Cov R 4 R, π β Va s 5 β Va R β Cov R, R β Tade 7 3, β Ds 8 4 β Lang Te sae o equy ssued by couny n couny s weal poolo s a uncon o couny s sae o wold make capalzaon, e expeced excess eun o couny ove couny, e 9 u, 8 9 See Solnk 974 o Secu 980 5

16 vaance o nomnal domesc euns, e covaance beween domesc and oegn euns, e nlaon edgng ably o domesc euns, nomnal excange ae volaly, and ee vaables desgned o capue lmed nomaon on couny by couny nvesos: oal blaeal ade as a sae o couny GDP, e pyscal dsance beween counes and, and an ndcao vaable o common language. β s equal o, couny s oldng e opmal sae o couny equy. β s less an, ey ae undeweg n couny equy. One way o measue ome bas sϕ β. Te lage s numbe s, e geae e degee o ome bas. Expeced euns ae measued as e aveage annualzed monly eun ove e pecedng yea. Fo example, e eal eun on Geman equy om e pespecve o a Bs nveso n 200 s measued as e aveage monly eal eun on Geman equy n e UK as gven by equaon 4 n Nomnal euns ae om e Mogan Sanley Capal nenaonal MSC o eac couny, wle nlaon and excange ae daa ae om e nenaonal Fnancal Sascs. Te vaances and covaances o euns, nlaon aes, and excange aes ae all compued concuenly w e sae yea. ncluson o e ade vaable pesens a poenal smulaney poblem. Wle nceased ade beween naons s lkely o lead o geae nomaon low, mg also be possble a counes ade moe because o a g degee o coss-bode equy lows? Fo example, suppose a Fenc eale wee o acque a mnoy equy sake n an alan wolesale m. As a esul, e eale as an added ncenve o do busness w e wolesale, as e peomance o e equy poolo wll be coelaed w e wolesale s poably. To conol o s poenal endogeney, ade lows ae nsumened w a gavy equaon. Speccally, assume a oal ade lows can be modeled as: Tade, 0 αy, α 2 y, α 3Ds α 4Bode α 5Lang u, α 9 Tade lows beween counes and ae a uncon o make szes poxed o by log GDP n bo counes, pyscal dsance beween counes and, an ndcao vaable equal o one counes and ae conguous, and a common language dummy vaable. Te dsance vaable s dened as e log pyscal dsance n klomees beween e wo lages ces n eac couny, aken om e CEP Geodesc Dsances Daabase. Te bode vaable s sel explanaoy, w e only excepons beng e pesence o a bode beween counes a wle no ecncally conguous, ave many o e eaues common o bodes. 0 Te language vaable s aly nclusve, w wo counes beng dened o ave a common language a 0 Examples o ese nclude a bode beween Fance and e UK anks o e Cunnel, and beween Denmak and Sweden a g numbe o ey cossngs 6

17 leas 0% o e populaon n eac couny speaks e same language. To esmae 8, we conduc a wo-sage leas squaes egesson, usng e nsumens gven n 9 o e ade vaable. Table 2 suggesed a ome bas ell ove me o counes bo nsde and ou o e EA, bu mos songly o e EA membes. How muc o s declne s due o e adopon o a common cuency and ow muc s due o oe acos? Do e causes o e declne vay wen lookng a deen caegoes o oegn equy oldngs? One way o es s s o augmen e bencmak model w neacon ems o bo e EA membesp and e pos euo-peod. Speccally, dene a new vaable Euo equal o one bo e domesc and oegn couny adoped e euo n 999. Te cange ove me s capued by e vaable Pos equal o o all obsevaons om 200 onwad. X, M,,, β β2 Euo * β3 Pos * β 2E M M M β Cov R, R 4 β Cov R 5 M R, π β Va s 6 M β Tade 7, β Va R β Ds 8 3 β Lang 9 u, Te new measue o bas s gven by ϕ β β2 β3. Te lowe s numbe, e close e algnmen beween a couny s oegn equy sae and a pedced by eoy. Home bas s dened acoss caegoes as: β β ϕ β β β β β β 3 Euo 0 and Pos 0 Euo and Pos 0 Euo 0 and Pos Euo and Pos A es o e mpac o e euo on na-ea ome bas would be β 2 0. Smlaly, a es o ome bas allng n e pos-999 peod would be β 3 0. bo coecens ae sgncanly posve, en ee s compellng evdence a ome bas as no only allen beween elave o 997, bu also a e bgges declne n ome bas as been o na-ea equy oldngs. Te esmaes n Table 3 conm s ypoess. Te s column pesens bencmak esmaes om unnng a egesson on equaon 7 w nsumened ade lows. Te coecen on oegn make capalzaon s 0.58, ndcang a subsanal ome bas acoss e ene sample. To nepe s coecen, suppose a a oegn couny s sae o wold Fo example, Swzeland saes a common language w Canada, Fance, Gemany, and aly among oes 7

18 make capalzaon nceased by %. Te bencmak esmae mples a e aveage esponse acoss e sample would be o ncease a oegn couny s equy sae n domesc poolos by only 0.58%, oldng all oe acos.e. baes o dvescaon consan. Eac o e vaables deved om e eoecal model n secon 4 ae pesened as sandadzed values. 2 neesngly, none o e coecens ae sgncanly deen om zeo, aloug nomnal excange ae sk s nealy so a e 0% level. On e oe and, e nomaon vaables all ave song and sgncan eecs on oegn equy oldngs. A % ncease n oegn ade sae leads o a 0.44% ncease n oegn equy sae, suggesng a counes a ade ogee end o nves moe eavly n one anoe. Pyscal dsance as a song negave eec on equy oldngs, w a % ncease n pyscal dsance leadng o pecenage pon decease n oegn equy sae. 3 Wee o no wo counes sae a common language s also a key deemnan, w oegn equy saes pecenage pons ge on aveage wen e oegn couny saes a common language. Te bencmak esuls ndcae a ome bas s pevalen acoss e sample, and a nomaon vaables suc as ade lows, dsance, and common language can explan muc o e vaaon n oegn equy saes. Te esuls n e second column o able 3 deenae beween EA membes and ousdes as well as beween e pe and pos-euo peods. na-ea equy oldngs dsplay a muc songe coelaon w e global equy poolo an equy oldngs nvolvng mulple cuences. Fo non-ea counes, ome bas s 9.%, compaed o 69.8% ome bas wn e EA. s e deence n ome bas smply acoss counes o as ee been a undamenal cange snce e noducon o e euo? Te sgncan coecen on e Pos neacon eec suppos e lae. Conollng o EA membesp o me peod does no meanngully cange any o e oe coecens n ee magnude o sgncance, aloug e explanaoy powe o e egesson does se slgly. Te d column n able 4 addesses e ssue o wee o no nvesos can dvesy sk nenaonally oug mulnaonals. 4 so, en some ome bas may be used. To assess s clam, e ouwad dec nvesmen poson o e ome couny n e oegn couny s ncluded as a egesso. e ome couny as a lage ouwad FD poson n e oegn couny, en domesc nvesos could us nves n e nave mulnaonals o aceve oegn dvescaon. As suc, we would expec e FD vaable o be negavely elaed o 2 Te vaables ae sandadzed by subacng e mean and dvdng by e sandad devaon o eac acoss e ene sample. Te coecens o e eun and excange ae vaables as well as ose on log dsance and common language ave all been mulpled by Wle s numbe seems small, consde a e aveage oegn equy sae n e sample s Te mpac o mulnaonals on ome bas s esmaed sepaaely due o gaps n e ouwad FD poson daabase. 8

19 oegn equy saes. n ac, e coecen on FD s negave, bu nsgncan. Ts may be due o e ac a a lage mulnaonal pesence nceases nomaon low abou a oegn couny, oseng e negave eec o mulnaonal pesence on dvescaon. n e second column o able 3, e mpac o EA membesp on ome bas was lage n magnude an a o e pos-euo peod. Ts would seem o ndcae a e EA counes smply ave moe dvesed poolos and a e noducon o e euo s no necessaly esponsble. Howeve, e pos-999 neacon em coves all ypes o oegn equy oldngs, ncludng counes bo nsde and ou o e EA. To deenae e eecs o e euo, we ee back o e ou classes o equy dened n secon 4:. Te sae o oegn EA equy n a EA poolo 2. Te sae o oegn non-ea equy n a EA poolo 3. Te sae o oegn EA equy n a non-ea poolo 4. Te sae o oegn non-ea equy n a non-ea poolo. Table 4 pesens esmaes acoss ese ou equy classcaons. By a, e lages decease n ome bas snce 999 was o na-ea equy oldngs. EA membes dsplayed a 67.7% ome bas owad oegn EA equy beoe e noducon o e euo. Ae bandng ogee n a moneay unon oweve, na-ea ome bas ell all e way down o 29%. No oe class o equy expeenced as lage a dop n ome bas n e pos-euo peod. Consde e conol goup: ome bas n e oegn non-ea equy o non-ea counes case 4 above. Po o 999, we esmae a e non-euo oegn equy oldngs o non-euo counes dsplay a 7.8% coelaon w e global equy poolo, a ome bas o 92.2%. Ae 999, ome bas alls, bu only o 84.9%. Tus, e omaon o e EA ad e lages mpac on equy oldngs wn e moneay unon. Lookng a equy oldngs beween EA membes and counes ousde e moneay unon conms s. Wle ome bas n EA oldngs o non-ea equy ell ae 999, e esmaed dop was less an a d as lage as a o na-ea equy oldngs. Te esmaed all n ome bas o non-ea oldngs o EA equy was even smalle and n ac no sascally sgncan. n all ou equy classcaons, nomaon specc vaables connue o be mpoan deemnans o oegn equy oldngs. Te exsence o a common language beween counes ends o ase equy oldngs, wle counes a ae close ogee end o nves n one anoe moe an ose a ae dsal. nsumened ade lows connue o ave a posve eec on oegn equy oldngs o all equy classcaons excep na-ea oldngs. Ts s 9

20 an neesng esul peaps mplyng a e omaon o a moneay unon umps e posve nomaon lows geneaed by ade beween wo naons. 7. Concluson Te cenal queson s pape soug o addess was wee o no e ceaon o a moneay unon educed equy ome bas. Te answe s a esoundng yes. Snce e noducon o e euo n 999, equy poolos acoss e Euo Aea ave become muc moe closely algned w ose a would exs n a bodeless wold. Wle nvesos acoss e wold ave begun o see e mes o nceased nenaonal dvescaon, e decease n ome bas as been nowee nea as ponounced as acoss e Euo Aea. Ts sould no be a supse, oweve. Te equy ome bas puzzle asks wy e pesence o naonal bodes pevens nvesos om explong welae mpovng oppounes. Te omaon o a sngle cuency aea and e coodnaon o moneay polcy beween naons educe e economc sgncance o naonal bodes wn e moneay unon. Te nnng o bodes appens bo decly oug e elmnaon o mulple excange aes and ndecly oug geae nomaon low oug ade. Wle cean caacescs suc as deen languages, culues, and egulaons eman o sepaae EA counes no dsnc enes, e lnes ave become blued. nvesos wn e EA no longe see e ellow membe saes as que so oegn. Tus, e educon n equy ome bas acoss e Euo Aea may smply be a e-denon o ome o Euo Aea nvesos. Regadless o e movaon bend nceased dvescaon acoss e Euo Aea, e decease n ome bas as been welae mpovng. Te mean vaance analyss n secon 2 ndcaed gans o be made om Geman dvescaon and smla oug less damac gans old o e oe EA counes. Ta ese gans ave become nceasngly ealzed snce e noducon o e euo ndcaes a geae sk sang oppounes need o be consdeed alongsde nceased ade as one o e benes o moneay unon. 20

21 Reeences [] Adaoue, K. and J-P Danne 2000, EMU and Poolo Dvescaon Oppounes, FAME Reseac Pape No. 3, nenaonal Cene FAME, Geneva [2] Adaoue, K. and Danne J-P 200, Poolo Dvescaon: Alve and Well n Euoland! CEPR Dscusson Pape No [3] Amad, A. and P. Begn 2006, Undesandng nenaonal Poolo Dvescaon and Tunove Raes, NBER Wokng Pape No [4] Babe, B. and T. Odean 2005, All a Gles: Te Eec o Aenon and News on e Buyng Beavo o ndvdual and nsuonal nvesos, Mmeo, p://ssn.com/absac [5] Ca, F. and F.E. Wanock 2006, nenaonal Dvescaon a Home and Aboad, NBER Wokng Pape No [6] Coope,. and E. Kaplans 994, Home Bas n Equy Poolos, nlaon Hedgng, and nenaonal Capal Make Equlbum, Te Revew o Fnancal Sudes, 7: [7] Coval, J. and T. Moskowz 999, Home Bas a Home: Local Equy Peeences n Domesc Poolos, Te Jounal o Fnance, 54:6 [8] De Sans, R.A. 2006, Te Geogapy o nenaonal Poolo Flows, nenaonal CAP-M, and e Role o Moneay Polcy. Euopean Cenal Bank Wokng Pape No. 678 [9] De Sans, R.A. and B. Gead 2006 Fnancal negaon, nenaonal Poolo Coce, and e Euopean Moneay Unon. Euopean Cenal Bank Wokng Pape No. 626 [0] Fauqee, H. S., L, and. Yan 2004, Te Deemnans o nenaonal Poolo Holdngs and Home Bas, MF Wokng Pape No. 04/34, nenaonal Moneay Fund [] Fellne, G. and B. Maceovsky 2003, Te Equy Home Bas: Conasng an nsuonal w a Beavoal Explanaon, Max Planck nsue Dscusson Papes on Saegc neacon No. 2003/03, Max Planck nsue o Economcs [2] Fankel, J. and A. Rose 998, Te Endogeney o e Opmum Cuency Aea Cea, Te Economc Jounal, 08, pp [3] Fenc, K. and J. Poeba 99, nveso Dvescaon and nenaonal Equy Makes, Te Amecan Economc Revew, May 99, 8:2 [4] Gnbla, M. and M. Keloau 200 How dsance, Language, and Culue nluence Sockoldngs and Tades, Te Jounal o Fnance, 56:3, pp [5] Hadouvels, G., Mallaopulos, D., and R. Pesley 200, EMU and Euopean Sock Make negaon, Mmeo, p://ssn.com/absac

22 [6] Jacqulla, B. & B. Solnk 978, Mulnaonals ae Poo Tools o Dvescaon, Jounal o Poolo Managemen, 4:2, pp8-2. [7] Jeske, K. 200 Equy Home Bas: Can nomaon Cos Explan e Puzzle? Economc Revew Fedeal Reseve Bank o Alana, 86:3, pp3-42 [8] Lews, K. 999 Tyng o Explan Home Bas n Eques and Consumpon, Jounal o Economc Leaue, 37:2 [9] Mcaeldes, A. 2003, nenaonal Poolo Coce, Lqudy Consans, and e Equy Home Bas Puzzle, Jounal o Economc Dynamcs and Conol, 28 [20] Poes, R. and H. Rey 2005 Te Deemnans o Coss-Bode Equy Flows. Jounal o nenaonal Economcs, v.65:2, p [2] Rouwenos, K.G. 998, Euopean Equy Makes and EMU: Ae e Deences Beween Counes Slowly Dsappeang? Mmeo, p://ssn.com/absac37435 [22] Rowland, P.F. and L. Tesa 998, Mulnaonals and e Gans om nenaonal Dvescaon, NBER Wokng Pape No [23] Secu, P. 980 A Genealzaon o e nenaonal Asse Pcng Model. Revue de l Assocaon Fancase de Fnance, v., p.9-35 [24] Solnk, B. 974 An Equlbum Model o e nenaonal Capal Makes. Jounal o Economc Teoy, v.8, p [23] Song, N. and X. Xu 2003, Undesandng e Equy Home Bas: Evdence om Suvey Daa, Te Revew o Economcs and Sascs, 85:2 [24] Tesa, L. and. Wene 995, Home Bas and Hg Tunove, Jounal o nenaonal Money and Fnance, 4:4 [25] Van Neuwebug, S. and L. Veldkamp 2007 nomaon mmobly and e Home Bas Puzzle. NBER Wokng Pape No

23 Table : Consumpon and Oupu Gow Rae Coelaons acoss e G-7 Counes Consumpon Coelaons Canada Fance Gemany aly Japan UK USA Aveage Canada Fance Oupu Coelaons Gemany aly Japan UK USA Aveage * Ognal daa s om e Penn Wold Tables coveng e peod Coelaons cove bo consumpon and oupu gow aes. 23

24 Table 2: Domesc Equy and Wold Make Capalzaon Saes Couny DES WMCP DES WMCP DES WMCP DES WMCP DES WMCP EA Membes Ausa 76.45% 0.6% 43.26% 0.09% 5.90% 0.4% 55.7% 0.7% 78.90% 0.23% Belgum 82.66% 0.60% 70.05% 0.6% 64.84% 0.55% 64.92% 0.55% 89.66% 2.03% Fnland 94.78% 0.32% 82.63% 0.70% 76.4% 0.60% 7.5% 0.54% 8.23% 0.48% Fance 86.3% 2.96% 82.60% 4.30% 8.8% 4.2% 77.59% 4.33% 80.20% 4.90% Gemany n.a. 3.63% 74.56% 3.93% 70.28% 2.98% 73.66% 3.45% 74.47% 3.5% eland 38.47% 0.22% -9.66% 0.28% -38.9% 0.26% % 0.27% 8.72% 0.30% aly 84.55%.52% 74.24%.93% 75.96% 2.08% 74.9%.96% 80.4% 2.08% Neelands 7.80% 2.06% 45.5%.68% 46.73%.75% 37.94%.56% 49.73%.64% Pougal 92.93% 0.7% 87.09% 0.7% 87.94% 0.9% 87.0% 0.9% 93.70% 0.9% Span 93.35%.28% 87.44%.7% 89.83% 2.0% 90.09% 2.32% 92.08% 2.48% Aveage 80.2% 2.9% 63.77% 5.39% 60.66% 4.76% 59.93% 5.35% 72.9% 7.48% "Home Bas" Non-EA Euope Denmak 78.85% 0.4% 63.27% 0.35% 64.25% 0.33% 68.29% 0.4% 77.44% 0.40% Noway 86.25% 0.29% 58.0% 0.25% 50.98% 0.29% 50.95% 0.30% 69.62% 0.37% Sweden 83.53%.20% 64.7% 0.85% 63.27% 0.77% 65.55% 0.92% 72.95% 0.99% Swzeland n.a. 2.53% 70.6%.9% 76.69% 2.4% 75.25% 2.32% 8.24% 2.8% U.K % 8.78% 75.23% 8.2% 73.0% 8.% 70.96% 7.7% 72.02% 7.43% Aveage 8.87% 3.2% 66.38%.48% 65.66%.9% 66.20%.65% 74.66%.37% "Home Bas" Non-Euope Ausala 88.36%.30% 83.36%.37% 83.30%.66% 83.98%.87% 87.88% 2.05% Canada 8.3% 2.50% 75.86% 2.57% 73.32% 2.50% 75.30% 2.86% 77.85% 3.% Hong Kong n.a..82% 89.66%.85% 90.36% 2.0% 89.55% 2.28% 89.60% 2.27% Japan 92.85% 9.74% 90.23% 8.25% 90.78% 9.25% 9.7% 9.7% 90.77% 9.70% Koea 98.7% 0.20% 99.48% 0.85% 99.38%.08% 99.4%.05% 99.06%.3% Sngapoe 85.% 0.47% 75.35% 0.43% 70.75% 0.44% 77.42% 0.46% 82.85% 0.45% Sou Aca n.a..02% 75.39% 0.32% 84.48% 0.80% 85.0% 0.86% 9.67%.20% U.S.A % 49.7% 90.20% 50.58% 89.44% 48.08% 87.72% 45.57% 87.37% 43.05% Aveage 89.38% 66.76% 84.94% 66.22% 85.23% 65.83% 86.9% 64.67% 88.38% 62.96% "Home Bas" * DES s Domesc Equy Sae, dened as e pecenage o a couny s equy poolo a s made up o domesc equy. WMCP s Wold Make Capalzaon Sae, denes as eac couny s conbuon o oal wold make capalzaon wee e wold s dened as all 4 counes n s sample. Te ow Aveage gves e aveage domesc sae o eac egon and e egon s oal sae o wold make capalzaon. Home Bas s dened ee as e ao o e domesc equy sae o make capalzaon sae o eac egon. Equy saes ae abulaed om CPS daa, wle make capalzaon s om e Wold Developmen ndcaos daabase. 24

25 Table 3: Te Deemnans o Home Bas Vaable Bencmak neacons Dvescaon w Mulnaonals Foegn Sae o Make Cap FMC A 0.58 EA*FMC B - Pos*FMC C - FD E [0.79] VR [0.50] Cov, [0.9] Cov -, π [0.356] Vas [0.02] Tade 0.44 Log Dsance Common Language Consan [0.00] [0.532] [0.95] [0.205] [0.25] [0.458] 0.7 [0.046] [0.07] [0.683] [0.56] [0.888] [0.759] [0.022] [0.750] 0.29 [0.004] [0.00] Sample Sze R Home Bas A EA beoe 999 A B EA ae 999 A B C F-sasc B C * OLS Esmaons o equaons 8 and 9 n e ex. Robus p-values ae gven n backes. Te dependen vaable n eac case s e sae o a pacula oegn couny equy on a couny by couny bass n a domesc equy poolo. Foegn Sae o Make Cap s dened as e oegn couny s sae o wold make capalzaon. EA s a dummy vaable equal o one bo e domesc and oegn counes use e euo ae 999. Pos s a dummy vaable equal o o all obsevaons ae 999. All oe vaables ae dened n secons 5 and 6 o e ex. Home Bas s dened as mnus e coecen on oegn make cap, w zeo ndcang no ome bas and epesenng a compleely closed economy. All equy eun and excange ae vaables ave been sandadzed and e coecens ave been mulpled by 00 o ease o nepeaon as ave ose on dsance and language. 25

26 Table 4: Home Bas acoss Equy Caegoes Home: EA Foegn: EA Home: Non-EA Foegn: Non-EA Home: EA Foegn: Non-EA Home: Non-EA Foegn: EA Vaable Foegn Sae o Make Cap FMC [0.038] [0.00] Pos*FMC [0.209] E [0.037] [0.444] [0.934] [0.427] VR [0.406] [0.75] [0.203] Cov, [0.08] [0.254] [0.672] Cov -, π [0.648] [0.062] [0.275] [0.505] Vas [0.495] [0.69] [0.05] [0.236] Tade [0.924] [0.09] Log Dsance [0.002] [0.977] Common Language [0.004] [0.40] Consan [0.00] [0.59] Sample Sze R Home Bas Beoe Home Bas Ae * OLS Esmaon o equaons 8 and 9 by egonal equy classcaon. Heeoskedascy conssen p-values ae gven n backes. Te dependen vaable n eac case s e sae o a pacula oegn couny equy on a couny by couny bass n a domesc equy poolo. Home ees o e classcaon o e domesc couny, ee n o ou o e EA. Foegn s e classcaon o e couny ssung e oegn equy. Fo example, Home: EA, Foegn: Non-EA lms e sample o us ose obsevaons n wc e epong couny uses e euo, bu e pane couny does no. An example o s would be e sae o Swss equy n an alan nveso s poolo. Te eun and excange ae vaables ave been sandadzed and e coecens mulpled by 00 o clay. All oe vaables ae dened n secons 5 and 6. Home Bas s dened as one mnus e coecen on oegn make cap, w zeo ndcang no ome bas. 26

27 Fgue a: UK vs. Euope, % Euope Mean Reun % UK % UK Sandad Devaon Fgue b: UK vs. Euope, % Euope Mean Reun % UK % UK Sandad Devaon * Rsk-eun adeo o poolos angng om 00% UK equy o 00% oegn equy, wee oegn s dened as a make cap weged Euopean ndex und excludng e UK. All euns and sandad devaons ae annualzed monly euns om e Mogan Sanley Capal ndexes MSC 27

28 Fgue 2a: Gemany vs. Euo Aea, % EA Mean Reun % Gemany Sandad Devaon Fgue 2b: Gemany vs. Euo Aea, % EA Mean Reun % Gemany -2.0 Sandad Devaon * Rsk-eun adeo o poolos angng om 00% Geman equy o 00% oegn equy, wee oegn s dened as a make cap weged aveage o e equy ndexes o Ausa, Belgum, Fnland, Fance, eland, aly, e Neelands, Pougal and Span. All euns and sandad devaons ae annualzed monly MSC euns. 28