Having a better education reduces people''s tendency to overinvest in their domestic economy, according to new research from the University of Glasgow to be presented at the Royal Economic Society''s 2015 annual conference.
What economists call the ''equity home bias'' is the puzzling habit of investors of concentrating their investments in domestic markets, even when there are few barriers to investing abroad and when international investments offer better returns. The study by Serafeim Tsoukas and colleagues shows that education, especially in financial literacy, might be a way to reduce the bias.
Analysing data from 38 countries in which investors show a strong bias towards investing domestically, they find that over the period from 2001 to 2010:
• A 10% increase in higher education leads to a 3.39% reduction in home bias.
• A similar increase in scores in the Programme for International Student Assessment (PISA) will drop the equity home bias by 1.24%.
• The link is more important for less financially developed economies.
The researchers conclude that an economy with more university graduates will display lower local equity bias. They also show that the relationship between education and reduced bias has been especially strong during the recent financial crisis.
Because it may lead to investors ignoring better returns in foreign markets, the equity home bias reduces the returns that they make. It may also lead to management inefficiency, because it reduces the threat that investors may walk out. Therefore reducing the bias is doubly important for policy-makers.
The authors conclude:
''Maintaining higher levels of education and financial literacy can substantially increase international portfolio diversification.
''Including financial education in a curriculum should be high on policy-makers'' agenda, especially for economies with less developed financial markets.''
Whether individuals choose to invest in their domestic assets or in international portfolios is an issue that is hard to ignore. Typically, investors seem reluctant to reap the full benefits of international diversification and overinvest in their domestic assets and this phenomenon is called the ''equity home bias puzzle''.
In their latest research, Udichibarna Bose, Ronald MacDonald and Serafeim Tsoukas of the University of Glasgow examine in detail the role of different facets of education and financial literacy in explaining the equity home bias puzzle for both more and less financially developed economies, paying special attention to the most recent financial crisis.
The authors document that economies with more university graduates display lower extends of local equity bias. This effect is stronger for economies with less developed financial markets. In addition, they show that the relationship is stronger for less financially developed economies, especially during the recent financial crisis.
The authors use a large country-level panel data-set for 38 countries over a period of 2001 to 2010 to investigate the influence of different facets of education on the equity home bias. The dataset is made up of countries that have highly home-biased equity portfolios.
The authors split their sample into more and less financially developed countries as countries with more developed financial markets are able to attract more foreign investments, resulting in a decline in home bias. They also distinguish between the financial crisis periods and tranquil periods to explore the impact of the crisis on portfolio diversification.
The authors find that different facets of education have a negative effect on the equity home bias. Economically, a 10% increase in tertiary education leads to a 3.39% reduction in home bias. An identical increase in PISA scores will drop the equity home bias by 1.24%. Moreover, this link is more important for less financially developed economies.
Finally, the authors take account of the response to the crisis by examining the sensitivity of home bias to education in the 2007-10 financial crisis. They find that education plays a more important role in reducing the equity home bias in economies with lower levels of equity market development during the crisis and non-crisis periods compared to more financially advanced economies.
This study on the role of education in international portfolio diversification is not only of academic interest but is also highly relevant for policy, in particular, but not only, in the current economic climate. The findings suggest that maintaining higher levels of education and financial literacy can substantially increase international portfolio diversification. Hence, including financial education in a curriculum should be high on a policy-maker''s agenda, especially for economies with less developed financial markets.