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Familiarity Breeds Investment: Migrant Networks and Cross-Border Capital
Unformatted Document Text:  5 that are negatively correlated returns in the home country. This allows an investor to achieve at least average returns while minimizing the overall variance of the portfolio. Empirical work, however, finds little support for the result of the ICAPM and documents the existence of a “home bias”--a situation where investors prefer to invest at home rather than abroad. 5 The “home bias” is puzzling because it means that investors are not only foregoing higher returns from investing abroad but they are also holding a portfolio that is not sufficiently diversified. Scholars have argued that a large measure of the home bias can be explained in terms of information asymmetries. Kang and Stulz (1997), for example, document that foreign investors in Japan disproportionally own more shares of those firms whose information is more readily available. More generally, Tesar and Werner (1995, p.479) argue that factors such as “language, institutional and regulatory difference” explain the propensity of investors to invest at home rather than abroad. French and Poterba (1991) also account for home bias with reference to a set of factors they broadly categorize as “familiarity” effects. Though not explicitly rooted in the ICAPM, scholars studying global capital flows have been concerned with the prospect that investors will not realize a return on their investment due not to the poor performance of the investment itself but rather because of expropriation risk. These studies are rooted in the commitment problem: investors in country j make decision to invest in country i 1 at time t and hope to realize a return at time t+1. Once the investment has been made, politicians in country i 1 have an incentive to expropriate the investment either directly through nationalization or indirectly by changing tax rules, altering investment requirements, and/or imposing capital controls. Knowing this, investors will be less likely to invest in country i 1 , preferring instead to invest in country i 2 or in country j if they believe the risk of expropriation is lower either of the latter two countries. 5 See French and Poterba (1991) and Tesar and Werner (1995). Lewis (1999) contains a review of the relevant literature.

Authors: Leblang, David.
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5
that are negatively correlated returns in the home country. This allows an investor to achieve
at least average returns while minimizing the overall variance of the portfolio.
Empirical work, however, finds little support for the result of the ICAPM and documents
the existence of a “home bias”--a situation where investors prefer to invest at home rather than
abroad.
5
The “home bias” is puzzling because it means that investors are not only foregoing
higher returns from investing abroad but they are also holding a portfolio that is not
sufficiently diversified. Scholars have argued that a large measure of the home bias can be
explained in terms of information asymmetries. Kang and Stulz (1997), for example, document
that foreign investors in Japan disproportionally own more shares of those firms whose
information is more readily available. More generally, Tesar and Werner (1995, p.479) argue
that factors such as “language, institutional and regulatory difference” explain the propensity of
investors to invest at home rather than abroad. French and Poterba (1991) also account for
home bias with reference to a set of factors they broadly categorize as “familiarity” effects.
Though not explicitly rooted in the ICAPM, scholars studying global capital flows have
been concerned with the prospect that investors will not realize a return on their investment
due not to the poor performance of the investment itself but rather because of expropriation
risk. These studies are rooted in the commitment problem: investors in country j make
decision to invest in country i
1
at time t and hope to realize a return at time t+1. Once the
investment has been made, politicians in country i
1
have an incentive to expropriate the
investment either directly through nationalization or indirectly by changing tax rules, altering
investment requirements, and/or imposing capital controls. Knowing this, investors will be
less likely to invest in country i
1
, preferring instead to invest in country i
2
or in country j if they
believe the risk of expropriation is lower either of the latter two countries.
5
See French and Poterba (1991) and Tesar and Werner (1995). Lewis (1999) contains a review of the relevant
literature.


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