Essays in International Finance

Abstract

The two essays in this dissertation are concerned with investors' decision making in the global environment. Finance literature has established that investors do not allocate their investments in mean variance efficient portfolios. Instead, variables such as economic development and familiarity impact the portfolio allocation at home and abroad. In my first essay, I investigate determinants of foreign diversification by more than thirty thousand institutions worldwide. Survey-based country-specific variables on cross-cultural behavior help to explain both home bias and diversification among foreign equities. In particular, investment funds from countries characterized by higher uncertainty avoidance behavior display greater home bias and are less diversified in their foreign holdings. Investors from countries with higher levels of individualism and masculinity display lower levels of home bias and are more diversified abroad. In my second essay, I examine 3,487 non-US institutions' portfolio allocations in US securities. International funds from geographically distant countries invest less in the US and in a narrower set of securities than institutions from geographically nearby countries. However the significance from geographical distance reduces, when I control for the time zone differential between the investor country and the US. This shows that information flow at least partially explains the familiarity based explanation of international diversification. I also show that cultural uncertainty avoidance impacts portfolio allocation, so that funds from countries with high uncertainty avoidance tend to underweight the US market, but overweight a small set of US benchmark portfolios with the amount they invest in the US.