- neutral price as compensation for bearing risk. the amount of compensation required will vary both with the actual riskiness, or variance, of the asset ’ s returns and with the investor ’ s degree of risk aversion. if familiarity reduces an investor ’ s uncertainty over expected returns to an asset, one would expect that that investor would discount unfamiliar assets more heavily than familiar assets. in such a case, differences between foreign and domestic investors ’ familiarity with an investment would lead to under - investment by foreigners relative to domestic investors, leaving an irreducible minimum bias toward investing locally. it is thus total risk, not neutral risk, that is arbitraged. h. markowitz, ” portfolio selection, ” journal of finance, vol. 7, no. 1 ( 1952 ), pp. 77 - 91. see h. g. grubel, “ internationally diversified portfolios, ” american economic review, vol. 58 ( 1968 ), pp. 1299 - 314 ; or b. h. solnik, “ why not diversify internationally rather than domestically? ” financial analyst journal, vol. 30 ( 1974 ), pp. 91 - 135. m. feldstein and c. horioka, “ domestic savings and international capital flows, ” economic journal, vol. 90 ( 1980 ), pp. 314 - 29. they could productively employ. a clear benefit of financial globalization is that, to the extent that it reduces home bias, savings will be better directed to the most promising investments in the world, increasing global economic growth and prosperity. however, so long as risk aversion exists and trust is enhanced by local familiarity, we cannot expect that home bias will fully dissipate. nevertheless, is globalization at least reducing home bias toward its minimum level? survey data collected in the united states suggest a large swing toward foreign investment. u. s. residents began to increase the share of foreign assets in their portfolios from less than 9 percent in the late 1970s to about 15 percent by the mid - 1990s. since then, the trend has leveled off. the increased allocation to foreign assets was broad based, encompassing portfolio flows into debt and equity securities as well as foreign direct investment. a substantial part of the swing to holdings of foreign assets by u. s. residents coincided with a significant liberalization of capital accounts in both developed and emerging - market economies. in western europe, as goods markets became increasingly integrated, capital accounts followed suit. starting in the 1980s

to minority shareholders, and that a substantial portion of home bias in those countries can be attributed to local holdings of closely held firms. additionally, staff at the federal reserve board and international monetary fund have shown that, for firms from emerging - market economies that meet u. s. standards for disclosure and protection of minority shareholder rights, u. s. residents hold the theoretically predicted proportion of company shares in their portfolios. thus, it appears that an improvement in global reporting and corporate governance standards could significantly reduce global home bias. j. miniane, “ a new set of measures on capital account restrictions, ” mimeo, johns hopkins university, november 2000. see a. dyck and l. zingales, “ why are private benefits of control so large in certain countries and what effect does this have on their financial development? ” mimeo, university of chicago, 2001 ; or t. nenova, “ the value of corporate votes and control benefits : cross - country analysis, ” journal of financial economics, forthcoming ; and m. dahlquist et alia, “ corporate governance and the home bias, ” journal of financial and quantitative analysis, forthcoming. h. j. edison and f. e. warnock, “ u. s. investors ’ emerging market equity portfolios : a security - level analysis, ” prepared for the imf global linkages conference, january 2003. so do derivatives markets that help to narrow the wedge between the perceived risk - adjusted returns of foreign and domestic residents on any particular investment. foreign exchange forward contracts and swaps have helped reduce the overall risk of securities denominated in foreign currencies or to transfer the risks to agents with either a greater appetite for risk or a longer investment horizon over which to smooth losses. even the imposition of capital controls, foreign exchange restrictions, or devaluations of fixed currencies can now be at least partially hedged through nondeliverable forward contracts that settle in dollars for the change in value of an underlying currency over some pre - determined period. credit default swaps now allow agents to hedge or exchange even sovereign risk. argentina ’ s recent default provided a powerful test of these new derivatives and proved their worth, perhaps even helping to limit contagion. the further development of derivatives markets, particularly in smaller economies where idiosyncratic risk may be more difficult to hedge, will likely facilitate greater cross - border flows and a more productive distribution of global savings. the coincident development of local derivatives