A Gravity Model For Bilateral Home Bias:: Beyond Distance

A Gravity Model for Bilateral Home Bias:
Beyond Distance
Crina Pungulescu?
? John Cabot University
Global Business Research Symposium 2018
Crina Pungulescu GBRS 2018 1 / 12

Previously On Two Established Concepts in Finance
The Home Bias “Puzzle”
Investors prefer domestic equity markets (French&Poterba

AER1991)
80% domestic equity in international portofolios.
Costs of home bias (HB)

foregone gains from international diversification.
20% to double lifetime (permanent) consumption (Lewis JEL1999)
A recent extension: bilateral home bias (a.k.a. foreign bias)

IMF’s Coordinated Portfolio Investment Survey
cross-border stocks of 80 source economies (reporting) and 241
destination economies (reported)


AER1991)




AER1991)



Gravity Models
Distance (the main gravity variable) matters
... in international trade, as a proxy of transportation cost (Tinbergen

Shaping the World Economy1962)
...in international finance, as a proxy for “barriers to interaction and,

more broadly, to cultural exchange” (Portes & Rey JIE2005)
...in explaining home bias (Bekaert & Wang 2009)

Gravity Models



Gravity Models



Gravity Models



This Paper Main Question
A Fresh New Variable
An artificial brain trained on more than 4 million articles is able to

produce a measure of similarity between concepts (i.e. countries)
that is human-like.
Does country similarity matter in gravity models (over and above

distance)?

This Paper Main Question
A Fresh New Variable
An artificial brain trained on more than 4 million articles is able to

produce a measure of similarity between concepts (i.e. countries)
that is human-like.
Does country similarity matter in gravity models (over and above

distance)?

From cognitive neuroscience and psycho-linguistics A novel technology
The Retina Engine
...emulates the way the human brain works in synthesizing

information.
...can convert any text into a numerical representation of its

meaning: “semantic fingerprint”
i.e. a 2D map of meanings (128 × 128 matrix of pre-defined

concepts) filled with the value 1 if the pre-stored meaning applies to
the word analysed, 0 otherwise
e.g. Italy: “renaissance”, “art, museums”, “empire, invasions",

“goals, goalkeeper", “imperium, legions, pompey, octavian"

The Retina Engine

information.




The Retina Engine

information.




The Retina Engine

information.




From cognitive neuroscience and psycho-linguistics A fine-tuned similarity measure
Similarity: Semantic Overlap of Two Fingerprints

Similarity = the proportion of bits that overlap in the semantic
fingerprints of two countries
Poland - Bermuda: 5%, Average similarity: 21%

Romeo - Juliet: 70%


Romeo - Juliet: 70%


Romeo - Juliet: 70%
Similarity vs. Distance
Why should country similarity be a better proxy than distance?
We are looking for a proxy for “barriers to interaction and, more

broadly, to cultural exchange” (Portes & Rey JIE2005)
Distance is a unique absolute concept.
Investors are human and process multiple concepts in relative

terms to one another.
e.g. Vienna - Bratislava: 59km, Vienna - Berlin: 523km

Austria - Slovakia: 31%, Austria - Germany: 41% similar

















Methodological Refinements Measuring Home Bias
Optimal Portfolio Weights

Home Bias (HB) = deviation from optimal mean-variance weights.
Data-based Optimal Weights = f (sample mean, variance)
unreliable sample estimates of mean (Merton JFE1980)
Model-based (I-CAPM) Weights = World Market Capitalization

Shares.
only as good as the model is at describing the data.
Alternative (Bayesian) weights - choice of optimal portfolio weights

allowing for mistrust in the model.
Bayesian updating (Pástor JF2000)
Multi-Prior correction technique (Garlappi, Uppal & Wang
RFS2007)
⇒ 3 measures of HB: data-based (too volatile), model-based,
Bayesian (combines model and data)


Shares.

RFS2007)


Shares.

RFS2007)


Shares.

RFS2007)


Shares.

RFS2007)


Shares.

RFS2007)
This Paper Empirical Analysis
Panel Data Analysis
panel data estimation allowing for fixed effects for both source and
destination countries
dependent variables (full sample, absolute values, positive values,
negative values):
Model-based (I-CAPM) bilateral home bias
Bayesian bilateral home bias
Model-based (I-CAPM) bilateral home bias (comparative sample)
explanatory variables:
initial level of home bias (2001), distance, similarity, imports,
common language, common border,
EU/EMU/OECD/NAFTA/ASEAN membership

Panel Data Analysis
negative values):

Panel Data Analysis
negative values):

This Paper Main Findings
Similarity Matters
...more similar countries appear less home biased towards each

other
...similarity explains negative home bias (i.e. suboptimal

overinvestment) better than distance
...the typical gravity variables (distance, trade links, common

border, common language, EU/EMU membership) affect home
bias

Similarity Matters

other


bias

Similarity Matters

other


bias

Extensions Further Questions
Interpretation of Similarity
information vs. trust

does the need for trust counteract the diversification rationale that is
fundamental in finance?
time variation and crisis effects

how does the impact of similarity vary over time?
has the crisis acted as an eye opener?
impact of similarity other dependent variables: bilateral trade,

portfolio equity, foreign direct investment, debt holdings...





















This Paper Conclusion
Final Remarks
A new proxy has been introduced to international gravity models:

country similarity based on the overlap of the semantic
Similarity impacts bilateral home bias over and above the typical
gravity variables (distance, common language, common border)
Overinvestment appears more driven by similarity than distance

Final Remarks


Final Remarks


A Gravity Model For Bilateral Home Bias:: Beyond Distance

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A Gravity Model for Bilateral Home Bias:

? John Cabot University

Global Business Research Symposium 2018

Crina Pungulescu GBRS 2018 1 / 12

The Home Bias “Puzzle”

Investors prefer domestic equity markets (French&Poterba

Costs of home bias (HB)

A recent extension: bilateral home bias (a.k.a. foreign bias)

Crina Pungulescu GBRS 2018 2 / 12

The Home Bias “Puzzle”

Investors prefer domestic equity markets (French&Poterba

Costs of home bias (HB)

A recent extension: bilateral home bias (a.k.a. foreign bias)

Crina Pungulescu GBRS 2018 2 / 12

The Home Bias “Puzzle”

Investors prefer domestic equity markets (French&Poterba

Costs of home bias (HB)

A recent extension: bilateral home bias (a.k.a. foreign bias)

Crina Pungulescu GBRS 2018 2 / 12

Distance (the main gravity variable) matters

... in international trade, as a proxy of transportation cost (Tinbergen

...in international finance, as a proxy for “barriers to interaction and,

...in explaining home bias (Bekaert & Wang 2009)

Crina Pungulescu GBRS 2018 3 / 12

Distance (the main gravity variable) matters

... in international trade, as a proxy of transportation cost (Tinbergen

...in international finance, as a proxy for “barriers to interaction and,

...in explaining home bias (Bekaert & Wang 2009)

Crina Pungulescu GBRS 2018 3 / 12

Distance (the main gravity variable) matters

... in international trade, as a proxy of transportation cost (Tinbergen

...in international finance, as a proxy for “barriers to interaction and,

...in explaining home bias (Bekaert & Wang 2009)

Crina Pungulescu GBRS 2018 3 / 12

Distance (the main gravity variable) matters

... in international trade, as a proxy of transportation cost (Tinbergen

...in international finance, as a proxy for “barriers to interaction and,

...in explaining home bias (Bekaert & Wang 2009)

Crina Pungulescu GBRS 2018 3 / 12

A Fresh New Variable

An artificial brain trained on more than 4 million articles is able to

Does country similarity matter in gravity models (over and above

Crina Pungulescu GBRS 2018 4 / 12

A Fresh New Variable

An artificial brain trained on more than 4 million articles is able to

Does country similarity matter in gravity models (over and above

Crina Pungulescu GBRS 2018 4 / 12

The Retina Engine

...emulates the way the human brain works in synthesizing

...can convert any text into a numerical representation of its

i.e. a 2D map of meanings (128 × 128 matrix of pre-defined

e.g. Italy: “renaissance”, “art, museums”, “empire, invasions",

Crina Pungulescu GBRS 2018 5 / 12

The Retina Engine

...emulates the way the human brain works in synthesizing

...can convert any text into a numerical representation of its

i.e. a 2D map of meanings (128 × 128 matrix of pre-defined

e.g. Italy: “renaissance”, “art, museums”, “empire, invasions",

Crina Pungulescu GBRS 2018 5 / 12

The Retina Engine

...emulates the way the human brain works in synthesizing

...can convert any text into a numerical representation of its