  This study investigates the relationship of the equity home bias with 1) the
country-level behavioral unfamiliarity, and 2) the home-foreign return
correlation. We set the hypotheses that 1) unfamiliarity about foreign equities
plays a role in the portfolio set up and 2) the correlation of return on home
and foreign equities affects the equity home bias when there is a lack of
information about foreign equities. For the empirical analysis, the proportion
of respondents to the question "How much do you trust? - People you meet for
the first time" is used as a proxy measure for country-specific unfamiliarity.
Based on the eleven developed countries for which such data are available, we
implement a feasible generalized linear squares (FGLS) method. Empirical
results suggest that country-specific unfamiliarity has a significant and
positive correlation with the equity home bias. When it comes to the
correlation of return between home and foreign equities, we identify that there
is a negative correlation with the equity home bias, which is against our
hypothesis. Moreover, an excess return on home equities compared to foreign
ones is found to have a positive correlation with the equity home bias, which
is consistent with the comparative statics only if foreign investors have a
sufficiently higher risk aversion than domestic investors. We check the
robustness of our empirical analysis by fitting alternative specifications and
use a log-transformed measure of the equity home bias, resulting in consistent
results with ones with the original measure.
