Industrial Specialization Matters: A New Angle on Equity Home Bias

This paper theoretically and empirically examines how industrial structure affects equity home bias. I embed portfolio choice in a multi-country, multi-sector Eaton-Kortum model in order to explore how sectoral productivity differences affect a country’s risk exposure and hence influence home bias. The model predicts that investors from highly specialized economies who want to hedge their risk have a strong incentive to avoid domestic assets. I confirm the prediction with the data by finding that home bias is negatively correlated with a country’s degree of industrial specialization. This finding unveils the interaction between intranational risk hedging across sectors and international risk hedging across countries.