Home Bias, Transactions Costs, and Prospects for the Euro: A More Detailed Analysis

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Home Bias, Transactions Costs, and Prospects for the Euro: A More Detailed Analysist

This paper brings together two strands of the international finance literature: home bias and transactions costs, and international portfolio flows and exchange rate movements. Each strand of the literature has substantial depth, and the questions that researchers investigate within each strand are not answered unequivo-cally. Consequently, we synthesize only some of the research and consider one general and one specific question: would the US dollar depreciate if the transactions costs associated with trading equities in non-US markets were to fall to the level of transactions costs on US exchanges? More specifically, given the inte-rest in Europe on the development of a single market – including a pan-European financial market – is the current value of the euro low relative to the dollar becau-se of higher transactions costs in European equity markets?

We focus on equity markets and the global portfolio behaviour of US and European investors, rather than the universe of assets (currency, official securities, corporate bonds) or investors. Equity markets have grown very rapidly in recent years as countries have deregulated financial markets, and the US and European equity markets account for about ¾ of world market capitalization.

Using cross-section regression analysis of the 1997 US Survey Benchmark data, our findings indicate that transactions costs, as distinct from information asym-metries, help to explain actual portfolio allocations. Using new survey data on firm-level equity holdings from The Economist, we confirm that European firms show home bias in their holdings of European equities. From the start of the EMU convergence period in 1997, the home bias of European firms falls as their holdings of US equities rises. We are unable to find evidence of home bias for the US firms in this sample.

For the full analysis, see

Home Bias, Transactions Costs, and Prospects for the Euro: A More Detailed Analysist. For more DB Research analyses see theDeutsche Bank Research website.  

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