Explaining Home Bias in Equities and Consumption

Domestic investors hold a substantially larger proportion of their welath portfolios in domestic assets than standard portfolio theory would suggest, a phenomenon called "equity home bias". In the absence of this bias, investors would optimally diversify domestic output risk using foreign equities. Therefore, consumption growth rates would tend to comove across countries even when output growth rates do not. Empirically, however, consumption growth rates tend to have a lower correlation across countries than do output growth rates, a phenomenon I call "consumption home bias". In this paper, I discuss these two biases and their potential relationship.