Going global : the changing pattern of U.S. investment abroad

Investors typically allocate only a small share of their portfolios to foreign assets. This pattern of investment behavior, known as ?home bias,? is puzzling because it causes investors to miss opportunities to diversify risks. During downturns in the U.S. economy, many domestic assets perform poorly, precisely when asset returns are most valuable. By purchasing foreign assets that are only partly affected by the U.S. business cycle, however, investors are able to hedge against adverse fluctuations in domestic income. ; Recent evidence suggests that home bias might actually be declining. Over the past decade, U.S. holdings of foreign financial assets?stocks and bonds?have grown remarkably. At the same time, foreign physical assets, such as foreign direct investment in production plants, have also become far more common. Overall, the share of U.S. investments allocated to foreign assets swelled from 40 percent of GDP in 1990 to 89 percent in 2005. ; Meirelles Aurlio investigates the recent behavior of U.S. foreign investment and the factors driving the change in its fastest growing category?namely, international equity investment. Home bias in U.S. equity investment has indeed declined during the last decade. However, the propensity to invest abroad has varied significantly across assets from different foreign economies. Specifically, U.S. investors tend to prefer investing in other industrial countries rather than in emerging markets. This pattern has likely developed because the assets of industrial countries provide a better hedge during downturns in the U.S. business cycle.