Aurora Borealis
1 May 2016 CFA Institute Journal Review

Education and the Local Equity Bias around the World (Digest Summary)

  1. Derek W. Johnson, CFA

Analyzing 38 countries, the authors examine the level of education and financial sophistication of the population and the tendency of investors to diversify internationally or maintain a home bias. They find that a higher level of education and greater math skills result in more international diversification, especially in less-developed countries.

What’s Inside?

The authors examine the level of education and financial sophistication of the population of 38 countries as well as the tendency of investors to diversify internationally or maintain a home bias. Local equity bias has been widely noted in previous literature; the authors build on this finding by examining how education and the level of mathematical skill affect this bias. They find that the level of education and financial skill affect a population’s willingness to diversify internationally. This tendency varies more in less-developed countries and was especially strong during the financial crisis in 2008–2009.

How Is This Research Useful to Practitioners?

Home bias has been a puzzle to practitioners and policymakers worldwide. Diversification offers investors access to higher returns with the added benefit of lower volatility. So, the question is why all investors do not take advantage of this opportunity. The authors postulate that the level of education and mathematical skill in various countries plays a critical role, which is especially noticeable in less-developed countries. Practitioners and policymakers could use this analysis to identify countries that would benefit from an increase in both higher education and international diversification. This focus on increasing the level of education and financial proficiency in less-developed countries could help promote a population’s ability to invest and save wisely, which the authors’ statistics and examples indicate to be the case.

The evidence of equity home bias among less-developed countries during the financial crisis is a key part of the authors’ findings. As the financial crisis developed, the tendency in all countries was to invest less internationally, especially in the more volatile emerging markets. But the authors find that even during the crisis, a higher level of education and financial proficiency made a difference in international diversification. This evidence helps validate the authors’ original findings.

How Did the Authors Conduct This Research?

The authors analyze investment data from 38 countries. They label a country as developed if its stock market capitalization is greater than the mean capitalization of all the countries analyzed. If the capitalization is less than the mean, it is considered less developed. The authors then examine the level of equity home bias as the difference between the proportion of the total equity invested in the home country and the relative weight of the domestic stock market in the global equity market.

They assess level of education and mathematical skill using three different indicators: university-level school enrolment rates, OECD-PISA math scores, and managers’ surveys. A higher level of education seems to imply a higher level of financial sophistication, so the authors expect that a higher level of education will result in lower equity home bias. They also examine various factors to determine financial development, such as macroeconomic conditions (e.g., GDP growth) and information-related variables (e.g., average of exports and imports and a country’s legal origin). They examine financial openness using the Chinn-Ito Financial Openness Index and determine financial market development using the country’s turnover ratio, domestic credit conditions, and stock market capitalization.

The authors run regression analysis on these variables to find their association with equity home bias. The analysis shows a clear correlation of educational level and financial skill with equity home bias. It is especially evident in less-developed countries and was consistent through the financial crisis starting in 2008.

Abstractor’s Viewpoint

Although there is a long history of ineffectual interventions by developed countries in less-developed countries in the area of finance, this research might be helpful to policymakers in less-developed countries. By promoting higher education and financial proficiency, policymakers could make lasting improvements in their population’s long-term financial wellbeing. As emerging economies strive to become more developed, the educational level of their overall populations remain an important variable.

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