Equity home bias in international finance : a place-attachment perspective 9780429278181, 0429278187, 9781000001433, 1000001431, 9781000008272, 1000008274, 9781000014792, 1000014797

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1. The Equity Home Bias Puzzle 2. Place Attachment 3. The Equity Home Bias Puzzle: A Place-Attachment Explanation 4. A Look into the Future

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Equity Home Bias in International Finance

This book provides a comprehensive and critical analysis of research outcomes on the equity home bias puzzle – that people overinvest in domestic stocks relative to the theoretically optimal investment portfolio. It introduces place attachment – the bonding that occurs between individuals and their meaningful environments – as a new explanation for equity home bias, and presents a philosophically multi-paradigmatic view of place attachment. For the first time, a comprehensive and up-to-date review of the extant literature is provided, demonstrating that place attachment is a contributing factor to 22 different topics in which variations of home bias are present. The author also analyses the social-psychological underpinnings of place attachment, and considers the effects of multiculturalism on the future of equity home bias. The book’s unique approach discusses the issues in conceptual terms rather than through data and statistical methods. This multi- and inter-disciplinary book is an invaluable resource for graduate students and researchers interested in economics, finance, philosophy, and/or methodology, introducing them to a new line of research. Kavous Ardalan is a Professor of Finance at Marist College, Poughkeepsie, New York, U.S.A. He holds PhDs in both economics and finance. His research interests are in the theoretical, practical, educational, social, and philosophical aspects of economics and finance.

Banking, Money and International Finance

8. Austrian Economics, Money and Finance Thomas Mayer 9. Price and Financial Stability Rethinking Financial Markets David Harrison 10. A Comparative History of Bank Failures From Medici to Barings Sten Jönsson 11. Expert Systems in Finance Smart Financial Applications in Big Data Environments Edited by Noura Metawa, Mohamed Elhoseny, Aboul Ella Hassanien, M. Kabir Hassan 12. Equity Home Bias in International Finance A Place-Attachment Perspective Kavous Ardalan 13. Frontier Capital Markets and Investment Banking Principles and Practice from Nigeria Temitope W. Oshikoya and Kehinde Durosinmi-Etti 14. French Banking and Entrepreneurialism in China and Hong Kong From the 1850s to 1980s Hubert Bonin 15. Banking, Lending and Real Estate Claudio Scardovi and Alessia Bezzecchi 16. The Regulation of Financial Planning in Australia Current Practice, Issues and Empirical Analysis Angelique Nadia Sweetman McInnes For more information about this the series, please visit www.routledge.com/ series/BMIF

Equity Home Bias in International Finance A Place-Attachment Perspective

Kavous Ardalan

First published 2019 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 52 Vanderbilt Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2019 Kavous Ardalan The right of Kavous Ardalan to be identified as author of this work has been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data A catalog record has been requested for this book ISBN: 978-0-367-23067-8 (hbk) ISBN: 978-0-429-27818-1 (ebk) Typeset in Bembo by Taylor & Francis Books

This work is dedicated to my family.

Contents

List of figures Preface

viii ix

1

The equity home bias puzzle

1

2

Place attachment

3

The equity home bias puzzle: a place-attachment explanation

122

4

A look into the future

198

Index

220

82

Figures

2.1 The tripartite model of place attachment 2.2 The four paradigms

84 93

Preface

This book introduces “place attachment” as a new explanation for the “equity home bias” puzzle – the empirical finding that people overinvest in domestic stocks relative to the theoretically optimal investment portfolio. Chapter 1 provides a comprehensive review of the extant literature on the equity home bias puzzle, and Chapter 2 offers an overview of the literature on place attachment. Chapter 3 crosses the two lines of research to propose place attachment as a new explanation for the equity home bias puzzle. Chapter 4 looks into the future of place attachment and its effect on home bias. The chapter synopses are as follows.

Chapter 1: The equity home bias puzzle This chapter reviews the literature on equity home bias – the empirical finding that people overinvest in domestic stocks relative to the theoretically optimal investment portfolio. It reviews six broad classes of explanation of this puzzling phenomenon: (1) hedging home risks; (2) barriers to foreign investments; (3) information asymmetries; (4) risk-aversion instability; (5) corporate governance and transparency; and (6) behavioral factors. The consensus is that none of the proposed theories can explain the full extent of the bias by itself, thus the international portfolio choice should be explained by a mixture of rational and behavioral factors.

Chapter 2: Place attachment This chapter discusses the concept of place attachment – the bonding that occurs between individuals and their meaningful environments. Place attachment has been examined in many fields of study, therefore it has been conceptually defined in various ways and through different methodological approaches. This situation could be regarded as chaotic, and some organizing frameworks would be helpful. Section 2.1 of this chapter discusses a tripartite framework for organizing definitions, and Section 2.2 provides a multi-paradigmatic framework for organizing methodologies.

x

Preface

Chapter 3: The equity home bias puzzle: a place-attachment explanation This chapter views place attachment as a contributing factor to equity home bias. It provides overviews of the literature on 22 topics in which variations of home bias are present, and notes that “equity home bias” is only one of these variations. The common contributing factor to all of the 22 home bias topics – including equity home bias – is place attachment. The 22 topics discussed in this chapter are: (1) equity investment, (2) bond investment, (3) equity analysts, (4) loan market, (5) saving-investment, (6) foreign stock listing, (7) currency, (8) international business, (9) international trade, (10) international marketing, (11) mergers and acquisitions, (12) economic nationalism, (13) corporate governance, (14) accounting standards, (15) government procurement, (16) academic research citations, (17) patent citations, (18) entrepreneurship, (19) entrepreneur location choice, (20) forum selection in law, (21) real estate, and (22) sport competition.

Chapter 4: A look into the future This chapter discusses “us and them” – a distinction that accompanies place attachment. The chapter argues that monoculturalism creates tension as it converts “us and them” to “us vs. them,” whereas multiculturalism mitigates the tension as it converts “us and them” to “us with them.” The chapter begins in Section 4.1 with a discussion of dual-process social psychology, which considers a spectrum with two extreme processes of effortless “heuristic” and effortful “systematic.” Whereas the heuristic process is more prone to bias, the systematic process tends to reduce the bias. Section 4.2 discusses place attachment as a cultural group’s definition of and relationship with place. Section 4.3 discusses the monoculture–multiculture spectrum, which contains the following stages: (1) monoculturalism, (2) cross-cultural contact, (3) cultural conflict, (4) educational interventions, (5) disequilibrium, (6) awareness, and (7) multiculturalism. The monoculture–multiculture spectrum operates in a parallel fashion to the heuristic–systematic spectrum. A typical resident who is socialized into the culture of a place takes such culture for granted and acts on it as his/her heuristic. However, if this typical resident of the place learns about multiculturalism, then he/she modifies the taken-for-granted culture and acts on it as his/her systematic. Section 4.4 argues that whereas the monoculture heuristic pair is biased, creates tension, and converts “us and them” to “us vs. them,” the multiculture systematic pair is unbiased, avoids tension, and converts “us and them” to “us with them.” In Section 4.5, the chapter concludes by stating that multiculturalism mitigates home bias. Writing the chapters of this book has involved extensive work over several years. It required peace of mind and extended uninterrupted research time. My deepest expressions of gratitude go to my wife Haleh, my son Arash, and my daughter Camellia for their prolonged patience, unlimited understanding, sustained support, constant cooperation, and individual independence during all these

Preface

xi

long years. I hold much respect for my late parents ( Javad and Afagholmolouk) who instilled in their children (Ghobad, Golnar, Alireza, and Kavous) the grand Ardalan family’s values of respect, openness, and love of learning, among others. I sincerely appreciate the heartfelt support of my in-laws (Farideh, Parviz, and Houman) who have always been in close contact with us since the formation of my immediate family. The ideas expressed in this work are based on the teachings, writings, and insights of Professor Gareth Morgan, to whom the nucleus of this work is owed. Needless to say, I stand responsible for all the errors and omissions. I would like to thank Professor Gareth Morgan who taught me how to view the world diversely and accordingly inspired my work. I am thankful to the Marist College library staff for their timely provision of the requested literature, which they obtained from various sources. I would also like to thank the publishers, referenced in the endnotes of each chapter, who allowed me to use their materials. Certainly, I would like to thank the respectable people who work at Routledge for their recognition of the significance of my work, and for their publication of the book with utmost professionalism. Kavous Ardalan, PhD Professor of Finance School of Management Marist College Poughkeespie, New York 12601 U.S.A.

1

The equity home bias puzzle

This chapter reviews the literature on “equity home bias” – the empirical finding that people overinvest in domestic stocks relative to the theoretically optimal investment portfolio. It reviews six broad classes of explanation of this puzzling phenomenon: (1) hedging home risks; (2) barriers to foreign investments; (3) information asymmetries; (4) risk-aversion instability; (5) corporate governance and transparency; and (6) behavioral factors. The consensus is that none of the proposed theories can explain the full extent of the bias by itself, thus the international portfolio choice should be explained by a mixture of rational and behavioral factors. Standard finance theory predicts that investors hold a diversified portfolio of equities across the world if capital is fully mobile across borders. More specifically, in a world with frictionless financial markets, the most basic international capital asset pricing model (CAPM) with homogenous investors across the world would predict that the representative investor of a given country should hold the world market portfolio. In other words, the share of his/her financial wealth invested in local equities should be equal to the share of local equities in the world market portfolio. This prediction contradicts the most casual observation of the data on portfolio holdings, which is the well-known home equity puzzle in international finance: Because foreign equities provide great diversification opportunities – a point made by DeSantis and Gerard (1997), Eldor, Pines, and Schwartz (1988), Grauer and Hakansson (1987), Grubel (1968), Kaplanis and Schaefer (1991), Lessard (1976, 1983), Levy and Sarnat (1970), Solnik (1974a) – falling barriers to international trade in financial assets over the past thirty years should have led investors across the world to rebalance their portfolio away from national assets toward foreign assets. The process of financial globalization fostered by capital account liberalizations, electronic trading, increasing exchange of information across borders, and falling transaction costs has certainly led to a large increase in cross-border asset trade (Lane and Milesi-Ferretti 2003). However, investors seem still reluctant to reap the full benefits of international diversification, and hold a disproportionate share of local equities. Despite better financial integration, the home bias has not decreased sizably: in 2007, U.S. investors still held more than 80% of domestic equities, a much higher proportion than the share of U.S. equities in the world market portfolio. Such home bias is often labelled as investors’

2

The equity home bias puzzle

suboptimal decision (Feldstein and Horioka 1980; Li, Sarkar, and Wang 2003). Indeed, home bias in equities is still observed in most countries and tends to be higher in emerging markets. Since the seminal paper of French and Poterba (1991), the home bias in equities has continued to intrigue and fascinate both financial economists and international macroeconomists. After French and Poterba (1991) brought home bias to prominence, Obstfeld and Rogoff (2001) nominated home bias as one of the six major puzzles in international macroeconomics. Papers such as Tesar and Werner (1995) show that home bias appears in bonds as well as equity, further deepening the home bias puzzle. Most of the literature has studied the more general case where individuals may invest in multiple assets in many countries (Adler and Dumas 1983; Stulz 1981a). It has been shown that home bias is not restricted to an international setting. Even within borders, there seems to be a tendency for investors to bias their portfolios towards firms that are situated in their own region. Many explanations have been put forward in the literature to explain this very robust portfolio fact, and these alternatives contribute to explaining parts of the gap. A number of studies have documented a significant yet slowly falling home bias in international financial portfolios among industrialized countries (Baele, Pungulescu and Ter Horst 2007; Cooper and Kaplanis 1986, 1994; French and Poterba 1990, 1991; Golub 1990; Heathcote and Perri 2013; Kang and Stulz 1997; Lane and Milesi-Ferretti 2006; Lewis 1995; Obstfeld 1995, Solnik 1991; Tesar and Werner 1994, 1995, 1998). This chapter reviews both the finance literature and the open economy financial macroeconomics literature, which has embedded nontrivial portfolio choices in standard two-country general equilibrium macro models – dynamic stochastic general equilibrium (DSGE) models.1 Cooper and Kaplanis (1994) report for several countries the proportion of equity investment in domestic equities and the domestic market capitalization as a proportion of the world equity market capitalization. For example, as of December 1987, U.S. investors placed 98% of their equity portfolios in domestic equities, against a figure of 36.4% for the U.S. market as a proportion of the world equity market capitalization. Comparative figures for other countries were: 78.5% against 10.3% for the United Kingdom; 86.7% against 43.7% for Japan; and averages of 85% against 1.9% for five continental European countries. French and Poterba (1991) document the domestic ownership of shares across countries. Using data for the United States, Japan, the United Kingdom, France, and Germany, they show that investors hold a disproportionate share of domestic assets in their equity portfolios. In 1989, 92% of the U.S. stock market was held by U.S. residents. Analogous numbers for Japan, the United Kingdom, France, and Germany were 96%, 92%, 89%, and 79%, respectively. Bohn and Tesar (1996) estimated the share of foreign equities in the U.S. portfolio to be still very low in 1995, equal to 8%. Tesar and Werner (1998) show that by the end of 1996 the fraction of stockmarket wealth invested in foreign assets was 10% for the United States, 11% for Canada, 18% for Germany, and 22% for the United Kingdom. These numbers

The equity home bias puzzle

3

have increased from a decade ago. In 1987 U.S. residents invested 4% abroad, Canadian investors 6%, and British investors 17%. Lewis (1999) reports that during 1970–1996 the correlation between the monthly returns on the U.S. and EAFE (Europe, Australia, and Far East) stock market indices was only 0.48. This modest correlation implies an allocation of at least 40% of the U.S. investors’ portfolio to foreign stocks. The actual U.S. allocation to foreign stocks is 8%. Ahearne, Griever, and Warnock (2004) show that at the end of 1997, U.S. stocks comprised 48.3% of the world market portfolio. At that time, foreign stocks represented only 10.1% of the stock portfolios of U.S. investors. Kollmann (2006a), based on the portfolio data from Kraay et al. (2005), shows that the average locally owned capital share for 17 Organisation for Economic Co-operation and Development (OECD) countries was 91% in 1997. Sercu and Vanpee (2007) analyze the data from the Coordinated Portfolio Investment Survey (held by the International Monetary Fund) and find that on average 70% of the total equity portfolio was invested in domestic stocks in all developed countries at the end of 2005. Sercu and Vanpee (2007) show that, at the end of 2005, all of the countries investigated held significantly home-biased equity portfolios. The equity home bias was lowest in the Netherlands, where only 32% of the total equity portfolio is invested in domestic stocks; and highest in Indonesia, where nearly all equity investments are domestic. In general, the equity home bias is lower in developed countries and higher in emerging markets. Coeurdacier and Rey (2013) note that in 2008, domestic equities constituted around 77.2% of equity portfolios of investors in the United States. This value is significantly larger than the United States’ 32.6% share in world equity market capitalization. Warren (2010) shows that, based on Australian Bureau of Statistics data, Australian superannuation fund assets as of December 2008 consisted of 82% in local assets, with an estimated 73% of the equity component comprised of local securities. At the same time, Australian equities comprised only 2.6% of the Financial Times Stock Exchange (FTSE) Global Equity Index Series. Evidence also points toward significant domestic bias in international bond portfolios. For example, Burger and Warnock (2003) find that foreign bonds comprised about 6% of U.S. investors’ bond portfolios in 1997, and 4% in 2001. Corroborating this evidence further, Fidora, Fratzscher, and Thimann (2007) show that there is substantial home bias in bond holdings for several advanced countries: Japan, the United Kingdom, Germany, Italy, and France. A measure of equity home bias that is most commonly used is the difference between actual holdings of domestic equity and the share of domestic equity in the world market portfolio. When the home bias measure for a country is equal to one, there is full equity home bias; when it is equal to zero, the portfolio is optimally diversified according to the basic international CAPM.

4

The equity home bias puzzle

On average, the degree of home bias across the world is 0.63 (lower in Europe where monetary union after 1999 appears to have had an effect (see Coeurdacier and Martin 2009 and Fidora et al. 2007 for studies on the impact of monetary union on cross-border equity diversification; Kalemli-Ozcan, Papaioannou, and Peydro 2010 show that the euro’s impact on financial integration was primarily driven by eliminating the currency risk). For the developed world, this means that the share of foreign equities in investors’ portfolios is roughly a third of what it should be if the benchmark is the basic international CAPM. Emerging markets have less diversified equity portfolios than developed countries and do not exhibit any clear downward trend in home bias. The average degree of home bias in these countries is 0.9 (smaller in emerging Asia and larger in Latin America), and investors in these countries hold one-tenth of the amount of foreign equities they should be holding according to the basic international CAPM model. Hau and Rey (2008) provide facts and relationships on home bias at the fund level. This robust evidence has received considerable attention in both the finance literature and the macroeconomics literature. The main difference between these two literatures relies on some modeling assumptions. To simplify, the traditional finance literature has tried to rationalize the equity home bias in multi-country models of portfolio choice where asset prices and their second moments are given (in particular in these models the risk-free interest rate is given exogenously). The finance models that use the portfolio approach to explain the home bias all proceed similarly. They posit an indirect utility function that depends on wealth and state variables. The investor maximizes the expected indirect utility function based on their expectation of the joint distribution of asset returns and state variables. Investors differ across countries because indirect utility functions and/or expectations of the joint distribution of returns and state variables differ across countries. These differences lead to a home bias. The macroeconomics literature has tried to integrate international portfolio decisions in otherwise standard DSGE models of the international economy. These models have a fully general equilibrium structure and asset prices and their second moments are determined endogenously. The finance literature tends to focus on the diversification gains, looking at asset price data to evaluate how an increase in the share of foreign equities would improve the portfolio performance, based on some criteria. The macrofinance literature tends to use consumption data to measure the potential welfare gains from international risk-sharing. The motivation is, however, the same: foreign equities seem to offer diversification benefits that are not reaped by investors, and both financial economists and macroeconomists are intrigued by this fact. The theoretical macroeconomic literature points toward potential gains from international diversification to hedge national production risk. In the presence of imperfectly correlated productivity shocks or output shocks across countries, owning foreign equity could help to smooth consumption. This is most obvious in the context of a two-country model with one single tradable good, as for example in Lucas (1982): in such a world, domestic and foreign investors

The equity home bias puzzle

5

hold an identical portfolio of claims to output (equities), the market portfolio, thus diversifying optimally national output risks. As in the textbook finance portfolio theory, in such a world the home bias in equities is seen as a failure of the standard diversification motive. However, one should be cautious: investors across the world would hold the same portfolio, only if they were homogenous. In reality, heterogeneity across investors from different countries leads to departure from the world market portfolio and potentially a bias toward national assets. Various sources of heterogeneity leading to equity home bias have been explored in the macro literature. They fall into two broad classes of explanation: hedging home risks – deviations from purchasing power parity (PPP) and nontradable assets risk; and barriers to foreign investments – such as transaction costs, differences in tax treatments and in legal frameworks, and other policy-induced barriers to foreign investment. The remainder of this chapter reviews the six broad classes of explanation for the equity home bias that have been brought forward in the literature. Section 1.1 discusses hedging home risks (deviations from PPP; nontradable assets risks; liabilities risks); Section 1.2 presents barriers to foreign investments (capital controls; transaction costs); Section 1.3 covers information asymmetries; Section 1.4 discusses risk aversion instability; Section 1.5 considers corporate governance and transparency; and Section 1.6 discusses behavioral factors. Section 1.7 concludes the chapter by summarizing the consensus that no single explanation can capture the full extent of international underdiversification on its own. Home bias is probably caused by a mixture of both institutional and behavioral factors, and therefore it is a very complex task to find a theoretical model that correctly describes actual portfolio choice.

1.1 Hedging home risks One potential explanation for the home bias in equity portfolios is that domestic assets serve as a better hedge for risks that are home country-specific. This is because investments in domestic assets are likely to follow the performance of the domestic market in general. Six home country-specific risks are considered that fall into three categories: deviations from PPP risks (inflation risk, real exchange rate risk, domestic consumption risk, nontradable goods risk); nontradable assets risk; and liabilities risk. 1.1.1. Deviations from purchasing power parity risks To understand the first source of risk, note that the framework used in the literature assumes that all investors perceive the same real returns as currencyadjusted inflation rates are equalized through PPP (Solnik 1974b). However, a large empirical literature has decisively rejected the hypothesis of PPP except perhaps in the very long run (Froot and Rogoff 1995). Thus, it would seem important to allow goods prices, and hence inflation rates, to differ across countries.

6

The equity home bias puzzle

Adler and Dumas (1983) point out an important feature that appears in international portfolio theory but not in domestic portfolio theory. Investors in different countries consume different bundles of goods. With inflation risk and deviations from PPP, investors in different countries are induced to hold portfolios that differ by a component designed to hedge inflation risk (Adler and Dumas 1983; Stulz 1981a). Thus, the home bias could be explained, as discussed by Sercu (1980) and Solnik (1974b), if domestic equities provide a hedge against inflation risk for some investors. It is possible to hedge inflation risk with domestic stocks only if the domestic stock returns and inflation rates are positively correlated. Empirical evidence for a positive correlation between stock returns and inflation rates is weak (Adler and Dumas 1983; Cooper and Kaplanis 1994; Sercu and Vanpee 2008), indicating that hedging inflation risk cannot explain the observed home bias. Cooper and Kaplanis (1994) test whether the home bias in equity portfolios is caused by investors trying to hedge inflation risk. They use data on foreign equity holdings across eight countries to ask whether inflation hedge motives can explain home bias. Their empirical evidence is consistent with this motive only if investors have very high levels of risk tolerance and if equity returns are positively correlated with domestic inflation. They find that the model is rejected and that sometimes the hedge motives are in the opposite direction to explain home bias. They conclude that the home bias cannot be explained by inflation hedging unless investors have very low levels of risk aversion. Thus, PPP deviations do not seem to explain the home bias phenomenon. Uppal (1992) has also contributed to this literature. Deviations from PPP not only create inflation risk, but also result in real exchange rate risk. Fidora et al. (2007) focus on the role of real exchange rate volatility as a key determinant of international portfolio allocation decisions. An interesting feature of their study is that it does not focus solely on stock holdings, but provides a link between the home bias in the stock and in the bond markets. Their model implies that real exchange rate volatility induces a higher home bias for assets with lower local currency return volatility, that is, a higher home bias for bonds than for equities. Fidora et al. (2007) find that for 40 home countries and up to 120 destination countries, real exchange rate volatility explains 20% to 30% of the cross-country variation in equity home biases and even a larger part of the variation in bond home biases. Another explanation given for the home bias is the existence of nontraded goods. This considers the desire of investors to hedge against the price uncertainty of nontraded goods that, in turn, leads to home bias. The hedging motive emanates from the difference in consumption bundles, as in the Adler and Dumas (1983) model. However, there is ample empirical evidence documenting incomplete international consumption risk-sharing. Indeed, Backus and Smith (1993), Kollmann (1995), and many other studies go by the names “Backus–Smith puzzle” or “consumption-real-exchange-rate anomaly.” Chue (2007) proposes a Euler equation to measure the extent to which foreign securities can serve as a better hedge against domestic consumption

The equity home bias puzzle

7

risks, relative to domestic assets. Chue finds that even though foreign equities can help diversify away domestic stock market risks, their ability in hedging domestic consumption risks is much weaker. Based on the Euler equation approach, there is only weak evidence that the existing degree of equity home bias for U.S. investors is suboptimal. Thus, Chue’s (2007) work provides no evidence that hedging domestic consumption risk can explain the observed home bias in equity portfolios. Lauterbach and Reisman (2004) offer a possible rational explanation for the home bias phenomena. They argue that since Duesenberry (1949), economists recognize people’s fundamental habit of comparing their economic welfare with that of their neighbors, peers, and social reference group. Individuals desire, first of all, to “keep up with the Joneses,” that is, preferences are defined over relative consumption (the ratio of individual consumption to that of their neighbors). Investors wishing to keep up with their neighbors (their compatriots, in our case) consider investments in domestic stocks favorably because they provide a better link to the local economy and to their compatriots’ economic welfare. Accordingly, investors seek some correlation with their compatriots’ future return and future consumption, that is, to the future domestic labor income and to the future return of local businesses. Thus, to tie their future economic welfare to that of their neighbors, investors favor domestic stocks. Therefore the home bias is a natural consequence of individuals’ desire to compare themselves and keep up with their neighbors. Their model predicts that globalization (increased correlation between the consumption and preferences of different nationals) would mitigate the home bias. Lewis (1996) shows why we may expect nontradables to play an important role in portfolio choice. Lewis finds that perfect risk-sharing cannot be rejected among a set of countries with unrestricted capital flows, as long as one allows for nonseparability in preferences between tradables and nontradables (consumption or leisure). In the context of the complete markets of Lewis’ (1996) model, the observed home bias can be explained only as the result of an optimum hedge against nontradables uncertainty. In the finance literature, optimal portfolios are structured to hedge the risk arising from real exchange rate fluctuations. This is at the heart of the potential divergence of portfolios across investors in the partial equilibrium portfolio choice models with real exchange rate risk. The key issue is whether local equities are a good hedge against relative price (real exchange rate) fluctuations, that is, whether local equities have higher returns when local goods are (relatively) more expensive. If this is the case, then local investors should favor local equities. Examples of this hypothesis are Adler and Dumas (1983), de Macedo (1983), de Macedo, Goldstein, and Meerschwam (1984), Krugman (1981), Solnik (1974a, 1974b), and Stulz (1981a, 1981b). Cooper and Kaplanis (1994) start with the premise that for equity home bias to be rooted in a desire to hedge against relative inflation, equity returns need to be positively correlated with inflation. They test for such a correlation and reject it for all countries considered. These papers take relative prices (and the real exchange rate) and asset returns as given, while in open economy financial

8

The equity home bias puzzle

macroeconomics the dynamics of goods prices and asset returns are endogenous, as is the covariance between the two. In the open economy financial macroeconomics literature, which is discussed in the rest of this section, some contributions focus on the hedging of the relative price of tradable goods (terms-of-trade), and some focus on the hedging of the relative price of nontradable goods. It is worthwhile to review a set of three approaches. One approach, exemplified in important papers by Kollmann (2006a) and Obstfeld (2006), focuses on a preference bias of agents toward consuming domestic goods. This bias is motivated by the empirical observation that the majority of private consumption falls on domestic goods. Then, with only country-specific endowment shocks, these models generate domestic bias in equity if the elasticity of substitution between domestic and foreign goods is less than one. The intuition for this result is the following. When a positive endowment shock hits the domestic economy, the terms of trade deteriorate and the real exchange rate depreciates. Since the domestic agent is biased toward consuming the domestic good, and that good has become cheaper, risk sharing involves holding an asset whose returns are relatively lower. With an elasticity of substitution lower than one, the deterioration in terms of trade is so strong that the return on domestic equity is, in fact, lower than that on foreign equity. Therefore, agents are biased toward holding domestic equity. A second important approach, best exemplified by Heathcote and Perri (2013), explains the observed equity bias by a negative correlation between relative domestic equity returns and relative non-diversifiable labor income. In their business cycle model with production and investment, domestic equity bias is an optimal way to risk share against country-specific productivity shocks. Given a positive productivity shock, labor income is higher, and therefore agents will hold primarily domestic equity if the return on it is lower than foreign equity. In their setup, equity is a claim to the capital stock, and the relative price of capital is equal to the relative price of consumption. A positive productivity shock depreciates the real exchange rate and thereby leads to a devaluation of the domestic capital stock. Under a range of parameter values, this devaluation is so strong that the return on domestic equity is lower than foreign equity. This mechanism relies on a preference bias toward the domestic goods in consumption and investment. In a third approach, Coeurdacier, Kollmann, and Martin (2009) generate home bias in equities without requiring equity positions to hedge against real exchange rate risk. In their endowment economy model, a new set of shocks, called redistributive shocks, redistribute income randomly between equity and non-diversifiable income. These break the perfect correlation between the real exchange rate and relative equity returns, while creating an incentive to hold domestic equity. In the presence of such shocks, to hedge against them, agents want to hold domestic equity because in states of the world where domestic equity income is lower due to a positive redistribution shock, non-diversifiable income will be higher.

The equity home bias puzzle

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In their influential contribution, Obstfeld and Rogoff (2001) argue that trade costs in goods markets help to solve the equity home bias puzzle. The model of Coeurdacier and Rey (2013), in line with Coeurdacier (2009), shows the opposite result for most parameter values. Indeed, in Obstfeld and Rogoff (2001), the coefficient of risk aversion is below unity (and equal to the inverse of the elasticity of substitution between the two goods), which allows the model to be solved in closed form. With such preferences, agents prefer to hold local equities that pay less when local consumption is expensive. A similar point is made by Uppal (1993) in a two-country/onegood model in continuous time with trade costs: he shows that home bias arises only for the coefficient of relative risk aversion (CRRA) smaller than one. One can potentially restore the argument of Obstfeld and Rogoff (2001) if some parameter values are altered, such as if the elasticity of substitution between goods is below unity. In that case, a fall in home supply triggers a very large increase in the home terms-oftrade such that home equity returns are high when prices of home goods are high. Hence, investors would rather hold local equities (Kollmann 2006b). In this class of models, equity home bias relies on the response of relative prices, that is, on the elasticity of substitution between local and foreign products. While time series macro data estimating the response of trade to exchange rate changes suggest a low elasticity of substitution, between 0.5 and 1.5 (Backus, Kehoe, and Kydland 1994; Heathcote and Perri 2002; Hooper and Marquez 1995), bilateral sectoral trade data suggest a large elasticity – above five for most sectors (Baier and Bergstrand 2001; Harrigan 1993; Hummels 2001). The parameter uncertainty makes it hard to get a conclusive answer from this class of models. It is also important to note that output fluctuations in all these classes of models are driven by supply shocks. In the presence of demand shocks, equilibrium portfolios could turn out to be different: when local demand is high, both prices of local goods and payoffs of local firms increase. Hence, demand shocks can generate positive co-movements between local equity returns and the price of local goods (Pavlova and Rigobon 2007). In order to be able to consume when demand is high, local investors would prefer local equities. Similarly, the presence of nontradable consumption exposes domestic agents to real exchange rate risk (driven by fluctuations in the relative price of nontradable goods). Stockman and Dellas (1989) develop a twocountry model with endowment economies. Each country has random endowments of a (single) traded good and a nontraded good. There is trade in equities of tradable and nontradable goods firms. With utility separable in tradable and nontradable consumption, optimal portfolios imply that domestic agents hold all of the equity of domestic nontradable firms. By holding all of the equity of nontraded goods, domestic agents hold an asset whose return is perfectly correlated with their expenditure on nontraded goods. Domestic agents hold the same share of home and foreign equity of tradable firms, implying perfect diversification in the tradable sector, as in Lucas (1982). Thus, this model generates home bias in equity positions, and the home bias increases in the share of nontradable

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The equity home bias puzzle

consumption in total output. Various papers have extended this framework to more general preferences, investigating in particular the nonseparability between tradable and nontradable consumption together with multiple tradable goods (Baxter, Jermann, and King 1998; Collard et al. 2009; Hnatkovska 2010; Matsumoto 2012; Obstfeld 2006; Serrat 1997, 2001). In these papers, the presence of nontradable consumption interacts with tradable consumption, and some degree of home bias in nontradable equities obtains. The precise structure of portfolios is strongly dependent on preference parameters, in particular the substitution elasticities between tradable and nontradable goods (and also between domestic and foreign tradable goods). The mechanism at the heart of the home bias toward nontradable equity is, however, essentially similar to the one described in the previous paragraph: investors want to hold equities whose payoff is high when the real exchange rate appreciates, that is, when the consumption of nontradable goods is expensive. It turns out that for a sufficiently low elasticity of substitution between tradable and nontradable goods [i.e., roughly below unity as found in the empirical literature – typical values used for the elasticity of substitution between tradable and nontradable goods are: 0.44 (Stockman and Tesar 1995); 0.74 (Mendoza 1995); from 0.6 to 0.8 (Serrat 2001); from 0.6 to 1.4 for developing countries (Ostry and Reinhart 1992); and see Matsumoto (2012) for a more detailed discussion], a fall in local nontradable output implies a strong increase in the relative price of nontradable goods together with an increase in local nontradable equity returns. Hence, local nontradable equity returns co-move positively with the price of nontradable goods (and the real exchange rate), leading to local equity bias in that sector. Jermann (2002) studies optimal portfolios in a multi-country general equilibrium model with endogenous labor-choice and nonseparable preference between consumption and leisure. The returns to human capital and the returns to domestic equities are positively correlated. However, since consumption and leisure are substitutes, consumption is highly valued in periods when work effort is high. Therefore, domestic claims provide the right hedge – local stocks serve as a good hedge against the labor income risk. Hnatkovska (2010) examines equity home bias and high turnover of international capital flows jointly in a two-country model with production and trade in equities. She finds that equity home bias can arise naturally in the presence of nontradable consumption risk, consumption home bias, and incomplete asset markets. Eldor, Pines, and Schwartz (1988), in a general equilibrium model, study N countries, each producing a nontradable good and the single tradable good that is consumed in all countries. The assets traded are “real equities” for the tradable and nontradable good. Tradable equities pay one unit of the traded good in each state of the world, while nontradable equity pays out “teta” units of the nontradable good, where “teta” is state-contingent nontradable output. They point out that for home bias to arise, the returns of nontraded equities have to be positively correlated with the price of the nontradable good and derive conditions for the risk aversion parameter, the price elasticity of demand for tradable goods, and the income elasticity of demand for tradable goods such that it would be the case.

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Feng (2014) proposes a DSGE model and demonstrates that shocks to consumption tastes (taste shocks) are an effective explanation for the equity home bias puzzle. In this model, home assets provide insurance for home agents to hedge against domestic taste fluctuations, whereas such insurance cannot be offered by foreign assets. The empirical evidence shows that, in explaining equity home bias, hedging against consumption taste risks is more relevant than hedging against labor income risks or real exchange rate risks. The author remains agnostic about the source of taste shocks, but adds that they can be interpreted as sudden changes in the opinions of agents or a form of consumer confidence (Pavlova and Rigobon 2007). The intuition for the insurance property of home assets is as follows. Suppose that there are two states of the world. In the state with a positive realization of home taste shock, home marginal utility becomes higher. With an endogenous labor supply, agents will consume more and accept a lower wage level, thus leading to a drop in the marginal cost of home production. The home firm thus increases production and earns a larger profit, which in turn boosts home equity return. Because home equities pay off well when home consumers want to consume more, home equities are attractive to home agents. The intuition also applies to the state with a negative realization of home taste shocks, where home assets pay off less when home consumers want to consume less; home assets are again attractive to home agents. The studies that are closest to Feng (2014) are those of Coeurdacier, Kollmann, and Martin (2007), Heathcote and Perri (2013), and Pavlova and Rigobon (2007), which show that taste shocks are important in producing equity home bias. Unlike these papers, Feng (2014) makes the labor supply endogenous, thus making it unnecessary for home asset returns to move in the same direction as domestic real exchange rates. Therefore, Feng’s (2014) model is not subject to van Wincoop and Warnock’s (2010) critique. On the empirical front, Pesenti and van Wincoop (2002) derive an expression that relates home bias to the correlation between equity returns and nontradable consumption growth. Using data on 14 OECD countries from 1970 to 1993, they find that, on average, nontradable consumption growth is positively correlated with the return on domestic capital. This would imply that home bias would arise if tradables and nontradable goods are complementary. The authors find, however, that even in those cases, hedging nontradable consumption could at best explain a relatively small fraction of the home bias observed in the data. More specifically, Pesenti and van Wincoop (2002) investigate to what extent nontradables (consumption and leisure) can affect the portfolio allocation decision in otherwise integrated capital markets. They note that about half of a consumer’s budget is spent on items that can be qualified as nontradable. Moreover, leisure can be considered a nontraded good as well. Fluctuations in nontradables can affect the optimal portfolio choice through their impact on the marginal utility from tradables consumption. They explain, for example, the case where leisure and consumption are substitutes. Intuitively, one can interpret leisure as nonmarket production (staying at home to take care of the

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baby) that can be substituted for market production (hiring a baby-sitter). When nonmarket production is low (that is, a cyclical upturn), the need to finance a larger amount of market consumption is strong. Investing in domestic assets makes it easier on average to finance such additional consumption, since the payoff on domestic assets is likely to be high relative to foreign assets during a boom. In other words, it is optimal to invest at home because there is a negative correlation between domestic asset returns and leisure. With regard to nontradable consumption, on the other hand, one might expect a positive correlation between asset returns and nontradables. In that case it becomes attractive to invest at home when tradables and nontradables consumption are complements. The authors cast their empirical analysis in the context of a simple continuous-time, infinite-horizon model with state-dependent utility of tradables consumption, where the state variable represents the stochastic endowment of nontradables. In the empirical application, asset returns are either equity returns or approximations of “fundamental returns” associated with claims on one period’s profits or claims on the present discounted value of firms’ profits. Their findings indicate that the explanatory power of their approach is, from any reasonable vantage point, very limited. They find that accounting for nontradables leads to only a small bias toward domestic assets. The bias is no larger than 27%, and probably much smaller than that. Current data, in contrast, show that the average bias toward domestic assets is close to 70% of the total portfolio. They conclude that hedging against nontradables shocks can account for only a small portfolio bias toward domestic assets. Berriel and Bhattarai (2013) explain why both international nominal bonds and equity portfolios are biased domestically. In their model, holding domestic government nominal debt provides a hedge against shocks to bond returns and the impact on taxes they induce. For this result, only two features are essential: nominal risk and taxes only on domestic agents. A third feature explains domestically biased equity holdings: government spending falls on domestic goods. Then, an increase in government spending raises the returns on domestic equity, providing a hedge against the subsequent increase in taxes. A calibrated version of their model predicts asset holdings that quantitatively match the data. Overall, there are two empirical difficulties with an explanation of the equity home bias that relies on the presence of a nontradable sector. The first one is that the structure of portfolios is strongly dependent on preference parameters, which are not easy to estimate. The second is that the home bias result relies on the ability of investors to hold separate claims on tradable and nontradable output: as most products contain both tradable and nontradable components, shares of firms automatically involve joint claims on tradables and nontradables. This difficulty is made all the more relevant by the fact that, when agents are allowed to trade separate claims on tradable and nontradable output, optimal equity positions are very different across the two sectors. This different structure of portfolios across traded and nontraded sectors seems inconsistent with casual empiricism, as argued by Lewis (1999). More broadly, empirical analysis of this channel is also hindered by the difficulty in identifying precisely nontradable consumption and tradable/nontradable equity.

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There is yet another major empirical issue faced by this explanation of home bias. The hedging of real exchange rate risk leads to equity home bias if local equities have higher returns (than abroad) when local prices are higher (than abroad). In other words, equity home bias appears if excess local equity returns (over foreign) increase when the real exchange rate appreciates. As shown by van Wincoop and Warnock (2006, 2010), the empirical correlation between excess equity returns and the real exchange rate is very low, too low to explain observed equity home bias. Furthermore, most of the fluctuations in the real exchange rate represent fluctuations in the nominal exchange rate, which can be hedged using positions in the forward currency market or the currency bond market. In other words, equities do not seem empirically to be an appropriate asset to insure investors against real exchange rate fluctuations. Hence, while these models are theoretically appealing, it is doubtful that the hedging of real exchange rate risk can account empirically for the equity home bias. Obstfeld and Rogoff (2001) suggest that it is worthwhile briefly reviewing what is perhaps an important explanation of the equity home bias that is based on the classic traded–nontraded goods dichotomy. While these two types of goods lie at polar extremes in terms of their tradability, equity claims on either type of industry can be traded without friction. Thus, even though cement is prohibitively costly to transport, there is nothing to stop foreign investors from buying shares in the domestic cement industry. Earnings, of course, must be redeemed in traded goods, since nontradables cannot be shipped to foreign equity holders by assumption. The key result one gets out of this framework is that, for the baseline case of separable preferences (across the two types of good), investors hold a globally diversified portfolio of traded goods industries. But nontraded goods industries are held entirely domestically. The intuition is that, since payments can only be made in traded goods and utility is separable, there is no way to enhance risk sharing in tradables by linking the allocation of tradables consumption to returns in nontraded goods industries. (That intuition has to be modified for the case of nonseparable preferences, but it is still a useful reference point. Baxter, Jermann, and King 1998 develop some results for the case of nonseparable preferences.) Thus, if nontraded goods constitute, say, 50% of total output (a popular rule of thumb based on the fact that for many OECD countries, services, construction, and transport constitute roughly 50% of GDP; see Stockman and Tesar 1995), then agents will (loosely speaking) hold more than half their equity in home assets. While elegant, this explanation still is not entirely satisfactory. First, although it goes some way toward explaining home bias, it falls short of explaining the 80% to 90% domestic equity shares actually observed. Second, the sharp dichotomy between traded and nontraded goods is a contrived one, since in reality transport costs differ across goods, and a particular good may or may not enter trade under different market conditions. For most goods, tradability is not absolute and tradedness is endogenous. Obstfeld and Rogoff (1996, chapter 5, especially pages 326–328) provide a thorough discussion of this matter.

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1.1.2 Nontradable assets risks A second source of country-specific risks that could potentially explain home bias arises from components of wealth that are not traded in financial markets, such as non-financial income and, especially, human capital, which is often considered the largest component of nonmarketable wealth. This explanation notes that the CAPM implicitly assumes that all wealth is liquid and tradable. Thus, the CAPM is typically measured with respect to a market portfolio of stocks and perhaps bonds. On the other hand, important components of wealth are not liquid, and still other components are not tradable at all. Therefore, the question is: do these nontradable assets provide a rationale for domestic residents to hold a disproportionately large share of their wealth in the domestic market? There are several reasons, though, why the symmetric portfolio based on market capitalization (i.e., CAPM) may not be the correct long-term benchmark. Traded securities such as equity and corporate bonds are effectively claims on some component of corporate profits. But corporate profits make up only about 10% of national income. Depending on the correlation between the return on traded and nontraded assets, residents in different countries will generally hold different portfolios. A number of studies have investigated the role of nontraded human capital for portfolio choice, in particular those by Baxter and Jermann (1997) and Bottazzi, Pesenti, and van Wincoop (1996). These two papers do not come to the same conclusion. Bottazzi et al. (1996) find a small home bias in optimal portfolios, while Baxter and Jermann (1997) report a large foreign bias. The main difference between the two papers is that Baxter and Jermann (1997) assume a stochastic trend in both wages and profits that differs across countries, while Bottazzi et al. (1996) assume a common trend among countries that does not affect international portfolio choice. Ghosh and Pesenti (1994) provide a theoretical survey of international portfolio models with nontraded labor income (see Pesenti and van Wincoop 2002). In a simple mean-variance model where human capital is a nontraded asset, Mayers (1973) shows that investors hold stocks to hedge the nontraded asset. If the return to human capital of an investor is negatively correlated with the return of the stocks from that investor’s country, then that investor would increase his/her position in domestic stocks relative to what would be predicted in a model without nontraded assets. Fama and Schwert (1977) were first to examine this issue for the U.S. and found little correlation. Obstfeld and Rogoff (1996) and Wheatley (2001) have also contributed to this literature. In the open economy financial macroeconomics literature, which is discussed in the rest of this section, hedging nontradable income risk implies picking stocks which have higher payoffs when labor income is low. The focus of the literature has been twofold: first, from a theoretical perspective, it has discussed the conditions under which standard macroeconomic models imply a negative or positive correlation between local equity returns and returns to nontradable wealth. Second, from an empirical perspective, a series of papers have provided estimates of the covariance between relative equity returns and relative returns

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to human wealth, which is the key empirical counterpart of portfolio biases in this class of models. The most influential contribution on these matters is that of Baxter and Jermann (1997), who argue that the presence of nontradable income risk worsens the equity home bias puzzle. Their argument goes as follows: in a standard multi-country real business cycle model with a single tradable good and a Cobb–Douglas production function, changes in output are shared in constant proportion between capital and labor. Hence, labor and capital incomes are perfectly correlated. As investors are already strongly exposed to domestic risk due to their labor income, they should not hold local capital. Due to the relatively large labor share in all countries, the effects of hedging domestic human capital dominate the benefits of diversification: investors should short-sell local equities. Hence, the equity home bias puzzle is worse than we think. The authors estimate a vector error correction model that allows the correlation between labor and capital returns to vary over time and be imperfect, while maintaining the assumption that the ratio of labor to capital income is stationary. Using data from the 1994 OECD National Accounts (OECD, n.d.) for Japan, the United Kingdom, Germany, and the United States for 1960–1993, they find that within countries, labor and capital returns are highly correlated, while the correlation between domestic labor returns and foreign equity returns is quite low. Using the observed correlations, the authors then construct diversified portfolios and find that the optimal position in domestic equity is negative in all the countries considered. Their empirical findings have been challenged by a series of papers. Bottazzi et al. (1996) use a continuous-time vector autoregression (VAR) model of portfolio choice and data on a large set of OECD countries and find that returns to domestic capital and human capital are negatively correlated for most countries except the United States, and this can explain a fraction of equity home bias in these countries. Julliard (2002) argues that Baxter and Jermann’s (1997) empirical findings are due to an econometric misspecification: the correlation between returns to human capital and local equity returns is overstated because they implicitly assume that innovations to capital and labor incomes are independent across countries. Once the misspecification is corrected, considering human capital risk does not unequivocally worsen the home bias puzzle. Using micro-level data, Massa and Simonov (2006) show that nonfinancial income is uncorrelated with the market portfolio of financial assets, but actual investors’ portfolios (which differ from the market portfolio) are more positively correlated with nonfinancial income than the market portfolio is. Thus, the authors cast doubt on the rationality of investors and on their desire to hedge nontradable income risk. From a theoretical perspective, Heathcote and Perri (2013) show that Baxter and Jermann’s (1997) result relies on very strong assumptions: one single and perfectly tradable good and a fixed capital stock. Relaxing those assumptions (in a two-country/twogood international real business cycle model à la Backus et al. 1994) and introducing differentiated product across countries together with consumption/investment home bias changes the picture drastically and

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helps solve the equity home bias puzzle. Their result relies on two key elements: endogenous capital accumulation and a strong adjustment of relative prices. The main intuition is the following. Suppose a positive (persistent) productivity shock hits the home economy. This leads to: 1 2

3 4

a fall in the relative price of home goods (foreign goods are scarcer); an increase in home investment (more than abroad) as home investment uses cheaper home goods more intensively (due to home bias in investment spending); an increase in home wages (more than abroad) and in the home returns to nontradable wealth; a decrease in the returns on home capital (relative to foreign) if the (relative) price response of home goods is strong enough.

The main difference with Baxter and Jermann (1997) is point (iv): if the market price of home goods falls sufficiently and home investment is increasing, dividends distributed by home firms (which are net of investment) are lower than abroad, and so are home returns to capital. Hence the model generates negative co-movements between home (excess) returns to human wealth and home (excess) returns to capital: hedging nontradable income risk implies home equity bias. Home bias in investment/consumption spending is important as it triggers a stronger response of investment at home, thus a larger fall of home dividends and a larger increase of home wages. Importantly, the model generates a positive link between consumption home bias and equity home bias as found in the data: Aizenman (2004), Heathcote and Perri (2013), and Lane (2000) show a positive relationship between trade openness and foreign equity holdings looking at a cross-section of countries; and Aviat and Coeurdacier (2007), Lane and MilesiFerretti (2008), and Portes and Rey (2005) show that country equity portfolios are strongly biased toward trading partners. Note that Heathcote and Perri (2013) focus on log-utility and unitary elasticity of substitution between home and foreign goods. Increasing the level of risk aversion introduces a real exchange rate risk motive as in Coeurdacier (2009) and Kollmann (2006b). Increasing the elasticity of substitution reduces the response of relative prices and makes the portfolio converge toward the Baxter and Jermann (1997) portfolio. The first generation of open economy financial macroeconomics papers presented above focus on equity positions to rationalize home bias. However, equities are only part of financial assets traded internationally. Debt securities (nominal bonds in different currencies, corporate bonds, bank deposits, etc.) are instruments that can also be used to share risks internationally. They should not be excluded from models, first for realism, since they constitute a large share of international asset flows, but above all because there might be substitution across asset classes. Hence, equity positions derived in equity-only models might be sensitive to the presence of other financial assets. Recent models with portfolio decisions have incorporated multiple assets (equities and bonds) to have more robust and realistic predictions (Berriel and Bhattarai 2013;

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Coeurdacier and Gourinchas 2016; Coeurdacier, Kollmann, and Martin 2009, 2010; Devereux and Sutherland 2007, 2008; Engel and Matsumoto 2009a, 2009b). Nominal bond returns differentials across countries are (almost) perfectly correlated with the real exchange rate (in developed countries, fluctuations in the nominal exchange rate account for most of the fluctuations in the real exchange rate). Hence, bonds are better suited than equities to hedge real exchange rate risk. But this is not the end of the story. The presence of bonds also affects the hedging properties of equities for nontradable income risk. Equities are used to hedge sources of risks that cannot be hedged through the bond positions, in particular the part of nontradable income risk that is orthogonal to bond returns. In this more recent literature, the optimal equity position depends, therefore, on the correlation of returns on equity with returns on nontradable income, conditional on bond returns. Coeurdacier and Gourinchas (2016) show, in a two-country, two-good, two-period endowment economy with trade in equities and bonds, how bond trading cast doubt on earlier findings of equities-only models. They show that in many theoretical environments, bonds are an excellent hedge for real exchange rate fluctuations. Using data on G7 countries, they show that the unconditional correlation between returns on equity and returns on nontradable wealth is very different from the conditional one: while the former is positive for all countries (as in Baxter and Jermann 1997), the latter is negative (or non-significant) for all countries, rationalizing the degree of home bias observed in G7 countries. Their findings echo the empirical results of van Wincoop and Warnock (2006, 2010) who show that equities are a very poor hedge for real exchange risk, and even more so when trade in nominal bonds (currency forwards) is allowed. A similar theoretical point is made by Engel and Matsumoto (2009a) in the specific case of a two-country/two-good DSGE model with monopolistic competition and sticky prices. Assets traded are domestic and foreign equity and positions in currency forward markets (which are equivalent to nominal bonds). Uncertainty is driven by productivity shocks and money supply shocks. Due to price rigidity, nominal exchange rate fluctuations are related to real exchange rate fluctuations and the forward positions are used to hedge the nominal exchange rate changes, leaving only a part of the relative price risk to be hedged by equity positions. The authors show that sufficient degrees of price rigidity can generate substantial home bias in equity positions, as domestic returns to human wealth and domestic equity returns are negatively correlated, conditional on nominal exchange rate changes. With monopolistic competition and price rigidities, output is partly demand-determined in the short run. Following a local positive productivity shock, labor demand falls. Wages also fall, leading to a fall in domestic labor income. Mark-ups and profits increase as, for the same level of production, labor costs go down. As price rigidities become smaller, there are two effects lowering home bias. Firstly, prices fall more following a positive productivity shock, increasing output and pushing up labor demand and wages. Secondly, the nominal and the real exchange rate become less closely related, making forward contracts less able to hedge fluctuations in relative prices. In the

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extreme case of full price flexibility, there is a reversion back to Baxter and Jermann (1997): labor incomes and profits are perfectly correlated and investors do not take any forward position as they do not want any exposure to purely nominal risk. Engel and Matsumoto (2009b) generalize the results above to the cases of local bias in consumption, producer currency pricing, and wage rigidity. Pang (2011) analyzes optimal portfolio decisions in a monetary open-economy framework. The author, in a simple two-country stochastic general equilibrium model, finds that market completeness and the specific form of nominal rigidities, namely, nominal price versus nominal wage rigidities, matter for justifying the observed structure of equity holdings. When markets are complete, sticky prices generate a negative correlation between the non-diversifiable labor income and the profit of domestic firms with respect to the productivity shocks, which explains why households invest little abroad. This reproduces the main result of Engel and Matsumoto (2009a, 2009b): with sufficient nominal price stickiness, equilibrium portfolios exhibit home bias if agents can diversify against risk arising from changes in relative prices. In contrast, when markets are incomplete, rigidities in goods prices result in a counterfactual “super home bias,” because domestic equities provide a good hedge against not only the labor income risk but also the relative price risk. Wage rigidities, however, have the opposite effect. The author, therefore, concludes that nominal rigidities in both goods prices and wage rates are needed to address the empirical composition of gross equity positions under incomplete markets. Rahbari (2009) develops a two-country DSGE model with price stickiness, endogenous capital accumulation, trade in nominal bonds and equities, and endogenous monetary policy. In his setting, equity home bias is again driven by the motive to hedge human capital risk. Real exchange rate risk is mainly hedged through bond positions due to price stickiness. He also shows that the combination of price stickiness and endogenous capital accumulation can produce relative equity returns that are unconditionally positively correlated with human capital returns, but conditionally negatively correlated (controlling for bond returns). This correlation pattern is confirmed using U.S. data. Devereux and Sutherland (2007, 2008) develop a two-country, two-good DSGE model with nominal rigidities, producer currency pricing, and endogenous monetary policy. The monetary authority sets the nominal interest rate in response to changes in producer price inflation. There is no local bias in consumption, and productivity shocks are assumed to be persistent. The authors consider different asset market structures (i.e., portfolio autarky; trade in nominal bonds; and trade in both nominal bonds and equity). They can generate home bias in equities for the same reason as Engel and Matsumoto (2009a). They also find that monetary policy assumes an additional role in these models. By changing the returns on nominal bonds, monetary policy affects portfolios and thus risk sharing. Interestingly, they find that while monetary policy has no impact on portfolios with trading in nominal bonds and equities, in the case of bond trading only, there is an additional motive for price stability. With price stability, crosscountry nominal bonds returns differentials become more correlated with the real exchange rate, which improves international risk sharing.

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Berriel and Bhattarai (2013) solve for equity and nominal bonds portfolios in a standard two-country general equilibrium model, in the presence of government spending shocks and nominal shocks (shocks to the price level): they investigate a new source of nontradable income risk, namely tax changes. In order to hedge fluctuations in taxes, households exhibit home bias toward local (government) nominal bonds and local equities. The main mechanism goes as follows: price level shocks at home (increase in home inflation) lower the value of home government debt, and the government can lower taxes (while still satisfying its intertemporal constraint). Hence, returns on domestic nominal bonds and local taxes co-move positively and the household prefers to hold local nominal bonds. Government spending shocks lead to an increase in taxes. In the meantime, as government expenditures are biased toward local goods, the relative price of locally produced goods increases and so does the pay-off of the claim to local output (local equity). Hence, returns on local equity and taxes co-move positively and households will optimally bias their portfolio toward local equity. Arespa (2015) provides a new benchmark for the analysis of home bias in a tractable new open economy macroeconomic model, where the home-biased position is an optimal allocation. Cole and Obstfeld (1991) is one of the first papers that, like Arespa (2015), departs from the widespread view that home bias is the result of market frictions or agents’ suboptimal behavior. Following their view, Heathcote and Perri (2013) and a small collection of papers argue that the home bias corresponds to the strategies of optimal rational agents for portfolio diversification. Arespa (2015) specifies an equilibrium model of perfect risk-sharing with endogenous portfolios and firm entry. In this model, the international portfolio diversification is driven by home bias in capital goods – independently of home bias in consumption when countries are of equal size. Concerning the bias on capital goods, a large part of the literature agrees that physical capital is mostly bought or built domestically. The model explains the recent patterns of portfolio allocations in developed economies. Most important, optimal portfolio shares are independent of market dynamics. 1.1.3 Liabilities risks Craft (2006) notes that typical asset portfolio models conclude that international equities should have a much higher portfolio allocation than what is actually observed. The author argues that this does not mean that pension managers have a home bias. What they may really be doing is minimizing the variance of the surplus return (i.e., assets minus liabilities) of the portfolio. In an asset/liability framework, portfolio allocations are determined not only by asset returns and variances, but also by correlations with the changes in the liabilities of the pension plan. Assets with higher correlations with pension liabilities would receive higher weights. The lower international equity allocations result from the low correlation between international equities and pension liabilities.

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In sum, explanations of home bias based upon the hedge properties of domestic equities do not seem to provide a truly convincing explanation of home bias towards domestic assets. In some cases, when domestic countryspecific risks are better hedged with foreign stocks, this type of explanation can actually deepen the home bias puzzle.

1.2 Barriers to foreign investments So far, the focus has been on hedging motives as a source of heterogeneity in portfolios assuming frictionless financial markets. A second feature of international portfolio investment that causes investors in different countries to hold different portfolios is the costs associated with cross-border investing (Black 1974; Cooper and Kaplanis 1986; Dahlquist et al. 2003; French and Poterba 1991; Lewis 1999; Stulz 1981b). These costs include policy-induced restrictions on foreign investments (such as limits to foreign investment, capital controls, differences in legal frameworks, and other barriers on trading equities, e.g., foreign stocks being more short-sale constrained than domestic stocks), fixed or proportional transaction costs in foreign portfolio investments, difference of tax treatments across domestic and foreign portfolio incomes, and informational disadvantages. These costs induce a home bias in equity portfolios because the net return on equities is higher for domestic than for foreign investors. 1.2.1 Capital controls For a number of years after World War II, most countries had strong barriers to foreign investment. Because most currencies were not convertible, investing abroad required access to scarce foreign currencies. Many countries also had prohibitions to foreign investment by their own citizens and often limits on, or outright prohibition of, ownership of domestic stocks by foreign investors. Indeed, governmental capital controls have historically generated significant hurdles to international investment. Under the Bretton Woods system, these controls were often imposed to help maintain some short-term autonomy of monetary policy. Following the breakdown of this system, many countries maintained taxes and other restrictions on international investment into the 1980s and even the early 1990s. More recently, however, the international trend has been toward more deregulation among both the capital markets of developed countries and the developing countries’ so-called “emerging markets.” One way to examine whether restrictions affect portfolio allocation is to examine securities prices from countries where these restrictions are prevalent, such as in emerging markets. The evidence suggests that the capital restrictions had been binding on foreign investors. Empirical studies show that deviations between the value of equities on domestic markets relative to international markets decline once international capital market liberalization is introduced, and vice versa (Bonser-Neal et al. 1990; Claessens and Rhee 1994; Hardouvelis, La Porta, and Wizman 1994). Stulz and Wasserfallen (1995) perform an

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event study of the removal of barriers to international investment for a Swiss stock. They show that when Nestlé made freely available shares that could be held only by Swiss residents, the price of these shares increased sharply as predicted. If governmental restrictions had been an impediment to investment, then the dismantling of these restrictions ought to increase foreign investment. This foreign investment increase should be particularly strong among investors with relatively low costs of transacting in financial markets, such as institutional investors. Indirect evidence for changes of foreign investment over time for these investors shows that from 1980 to 1990 and then to 1993, the foreign securities portion of pension funds increased for all countries considered. This increase is particularly striking as pension fund managers are often restricted in the size of their foreign portfolio allocations. On the other hand, the data generally suggest that home bias is still prevalent, even among institutional investors. Evidence for a rise in foreign holdings by mutual funds is more mixed than for pension funds. With the exception of the U.S., the foreign allocation of mutual funds has either remained about the same or even declined, as in the case of Germany. Moreover, the foreign share of both mutual funds and pension funds is quite low in the U.S., at 10% and 5.7%, respectively. Black (1974) derives a model of international portfolio choice and asset pricing where barriers to international investment take the form of a proportional tax that is rebated for short sales. Barriers of this type might correspond to some types of taxes, but generally obstacles to investment are such that they reduce the return for both short and long positions. Stulz (1981b) models such barriers as the equivalent of a tax paid on the absolute value of holdings of foreign stocks, and shows that they imply that some foreign stocks are not held by domestic residents. This tax can represent explicit direct costs of holding foreign stocks as well as proxy for other indirect costs, such as information costs. Other barriers to international investment take the form of outright ownership restrictions. Errunza and Losq (1985) and Eun and Janakiramanan (1986) provide models that examine the portfolio and asset pricing implications of such barriers. A number of papers investigate empirically the implications of partial segmentation, where partial segmentation is defined to mean that there are some equity flows that take place either in or out of a country, but these flows are limited because of explicit constraints on, or barriers to, international investment. In particular, it is common in the literature to contrast global pricing of assets with local pricing of country portfolios. When using developed markets for the 1980s and 1990s, authors generally find that they can reject local pricing of country portfolios. However, for a number of countries, some of the barriers to international investment are known explicitly, so that a model that reflects these barriers can be tested. Errunza and Losq (1985) derive explicit predictions for the expected returns of securities that cannot be held freely by foreign investors and test these predictions on a short sample period, and obtain results that are consistent with their predictions. Hietala (1989) tests a model where he

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incorporates the ownership restrictions that applied to Finnish companies over his sample period and finds supportive evidence that the magnitude of the premium of unrestricted shares relative to restricted shares can be explained by his model. Bailey and Jagtiani (1994) investigate the determinants of the premium of shares available to foreign investors in Thailand and show how that premium varies over time. With explicit or implicit barriers to international investment, securities available to foreign investors may not be equally attractive to all foreign investors since the barriers may differ across investors depending, for instance, on their tax status. In this case, the demand curves for domestic securities from foreign investors may be downward-sloping, creating incentives for firms to restrict their supply of shares available to foreign investors to increase the price of these shares. Stulz and Wasserfallen (1995) expand models with barriers to international investment to take into account the downward-sloping demand curves for domestic securities from foreign investors. They find supportive evidence for Switzerland. Domowitz, Glen, and Madhavan (1997) investigate the pricing of restricted and unrestricted shares in Mexico and find support for the hypothesis that the demand curve for Mexican shares from foreign investors is downward-sloping. In recent decades, barriers to international investment have fallen dramatically. Emerging markets took longer to remove explicit barriers to international investment. However, even for emerging markets that have few such explicit barriers, sovereign risk often remains as a significant barrier to international investment. Furthermore, in these markets, there have been instances where barriers have been restored – the most visible case being Malaysia in 1998. Bekaert and Harvey (1995) estimate a multivariate generalized autoregressive conditional heteroskedasticity (GARCH) model where the degree of integration of an emerging market changes over time, and then they extract from the data the extent to which the market is segmented. With their approach, the risk premium on a market depends on its volatility if the market is completely segmented, and depends on its world market beta if it is completely integrated. They allow a market’s expected return to depend both on its volatility and on its world beta. The degree of segmentation of a market decreases when the market’s world beta becomes a more important determinant of the market’s expected return. They find that the degree of segmentation varies over time – sometimes decreasing and sometimes increasing. Bekaert and Harvey (2000) and Henry (2000) provide evidence on the impact of removing barriers to international investment for emerging markets. When a country’s risk premium is determined locally, the mean-variance model implies that the risk premium increases with the volatility of that country’s market. In contrast, when a country’s risk premium is determined globally, the risk premium depends on the covariance of the return of that country’s market portfolio with the return of the world market portfolio. Because emerging markets typically have high volatility but low betas, one would expect their equity to appreciate substantially when they move from local to global pricing. Henry

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(2000) shows that it is so. Investigating a number of countries, he finds that on average the equity of these countries appreciates by more than 25% over the eight months that precede the opening of their markets and the month of the opening. Further, Chari and Henry (2001) provide evidence supportive of the hypothesis that the expected return of individual stocks is determined by their local beta before their markets open up to foreign investors, and by their global beta afterwards. While Henry investigates stock index returns around stock market openings, Bekaert and Harvey (2000) investigate changes in dividend yields. They provide a battery of econometric tests showing that, even though the risk premium falls, a reasonable estimate of this decrease in the risk premium is only at most between 100 and 200 basis points. The small decrease in the risk premium following the opening of a market to foreign investors is puzzling. Since the beta of emerging markets is so low and their volatility is so high, one would expect a much more dramatic impact. The home bias may help explain this low impact of stock market liberalization on the risk premium of emerging markets. The dramatic change from local to global pricing takes place only if, after liberalization, foreign investors begin to hold stocks of the liberalizing country in proportion to their weight in the world market portfolio. Indeed, they do not do that. If they did, the holdings of domestic stocks by domestic investors in emerging markets would be trivial since the share of an emerging market in the world market portfolio is typically less than 1%. Obviously, foreign holdings of emerging market stocks are not as extensive. Many years ago, it was not unrealistic to assume that explicit barriers cause home-biased portfolios. For many investors, investing in foreign securities was almost impossible because their country forbade them to do so, or made it difficult or impossible for them to obtain foreign currency. Since the early 1990s, nearly all countries have liberalized their financial markets, at least to a certain extent. These days, all developed markets and a number of emerging markets are open to foreign investors. In other words, equity home bias, which is highly persistent and still prevalent, cannot be explained by international capital controls. 1.2.2 Transaction costs Another explicit market friction brought forward as an explanation for the home bias is the existence of transaction costs. This explanation for equity home bias is based on the argument that the gains from diversifying abroad are insufficient to warrant the costs involved. If the costs of acquiring and/or holding foreign equities are sufficiently high, then investors may be induced to keep their savings at home. There is a wide debate on the importance of transaction costs to explain biased international portfolio decisions. The costs of international diversification include international taxes, informational costs, and other barriers to trade equity. Some cost differences prevail. Withholding taxes are not always able to be offset, and tax credits can be available on local investments (e.g., dividend

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imputation in Australia). In addition, higher management fees are often charged on global funds. Jeske (2001) observed that the average expense ratios for iShare index funds listed on the American Stock Exchange (AMEX) were 64 basis points per annum greater for foreign funds than the Russell 2000. Theoretical studies have clarified the relationship between returns and taxes (Black 1974; Errunza and Losq 1989; Stulz 1981a). Some empirical evidence has suggested that markets are segmented due to taxes and other restrictions. Errunza and Losq (1985) take a restricted version of Stulz’s (1981b) model and test it. Martin and Rey (2004) develop a two-country model with incomplete asset markets in which the demand for foreign assets decreases with transaction costs in a nonlinear way. Those transaction costs can include banking commissions and variable fees, exchange rate transaction costs, and information-gathering costs. Martin and Rey (2004) show theoretically that a severe equity home bias can result from only small transaction costs. Moreover, a size effect comes up due to the presence of these transaction costs and the imperfect substitutability of financial assets: shares from a large country trade at higher prices and have lower expected returns than those from a small country. Harms, Hoffmann, and Ortseifer (2015) show that incorporating distribution costs into a general equilibrium model of international portfolio choice helps to explain the home bias in international equity investment. Their model is able to replicate observed investment positions for a wide range of parameter values, even if agents have an incentive to hedge labor income risk by purchasing foreign equity. This is because the existence of a retail sector affects both the correlation of domestic returns with the domestic price level, and the correlation between financial and non-financial income. Transaction costs are often assumed to be small, although direct measures of these costs do not often exist. However, as shown by Bhamra, Coeurdacier, and Guibaud (2014), Cole and Obstfeld (1991), Martin and Rey (2004), and van Wincoop (1999), even small transaction costs may lead to sizable home bias when home and foreign stocks are close substitutes: any small transaction cost is amplified if the benefits of diversification provided by foreign assets are small. The costs of underdiversification can be estimated using various approaches: (1) a mean-variance portfolio approach; (2) a consumption approach; and (3) an individual portfolio holdings approach. Diversification costs estimation based on a mean-variance portfolio approach In a mean-variance framework, home bias can result from a difference between domestic and foreign investors in the expected returns and/or in the risks (covariance structure) of the assets in the investment set. Several studies consider models where investors adjust their expected returns of foreign assets downwards to reflect market frictions such as transaction costs, information asymmetries, and controls on international capital flows (Cooper and Kaplanis 1994, 2000; De Moor, Sercu, and Vanpee 2010; French and Poterba 1991; Glassman and Riddick 1994, 2001; Sercu and Vanpee 2008; Solnik 1996).

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Subtracting the costs of investing in foreign assets from the expected returns of these assets results, ceteris paribus, in home asset bias. French and Poterba (1991) use a simple mean-variance framework to back out investors’ returns expectations from observed portfolio weights, assuming the variance–covariance matrix is constant over time and known. Using stock returns data from 1975 to1989 for the United States, Japan, the United Kingdom, France, Germany, and Canada, the authors use estimates of a covariance matrix of returns together with an optimal portfolio rule that is implied by constant relative risk aversion in order to back out the differences in expected returns needed to explain actual portfolio shares for these countries. The implicit excess return on domestic equity implied by observed portfolio holdings is then interpreted as a measure of the cost of international asset trading needed to generate the observed home bias. They find an order of magnitude for these costs of several hundred basis points. The authors conclude that investors must expect returns in their domestic equity market to be several hundred basis points higher than abroad, which is too big to be true. Glassman and Riddick (2001) and Jeske (2001), following French and Poterba (1991), compute implied expected returns based on the vector of actual portfolio shares, the CRRA, and the covariance matrix of risky asset returns. The difference between historical returns and the implied returns is interpreted as the implicit costs of foreign investments. Returns are deflated by the Consumer Price Index (CPI) to control for inflation risk. Assuming a level of relative risk aversion of 3, Glassman and Riddick (2001) estimate that over the period 1985 to 1990, implicit investment costs for France, Germany, Japan, and the U.K. should have been in excess of an extraordinary magnitude of 14% to 19% p.a. to explain the observed home bias in equity portfolios. Jeske (2001) calculates the shadow cost of foreign investment for a sample of 11 countries over the period 1991 to 2000, also assuming a level of relative risk aversion of 3. The shadow costs of foreign investments are estimated to be 1.5% p.a. for the U. S., 4.5% p.a. for Germany, 7.6% p.a. for Spain, and 14.7% p.a. for Italy. These cost estimates are far larger than any reasonable measure of explicit or implicit costs since they are nearly as large as the actual returns themselves. However, the comparison of implied expected returns with historical mean returns to measure the costs of foreign investments is problematic for several reasons. First, realized returns are very bad proxies for expected returns because their estimates are extremely noisy (Merton 1980; Elton 1999) and a simple mean historical return does not account for the fact that expected returns can be time-varying. Second, the results are dependent on a postulated, and perhaps debatable, value for relative risk aversion. Third, the methodology does not account for either omitted assets (notably long-term bonds and nontraded assets) or exchange rate risk. Cooper and Kaplanis (1994) derive an international portfolio holdings model – which is an extension of the international CAPM of Adler and Dumas (1983) and Sercu (1980) – it accounts for both domestic inflation risk and deadweight costs of foreign investments. In a setting with N countries and N currencies, there are N equity assets, N – 1 foreign currency bills or notes, and

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a nominally risk-free asset. A crucial assumption of the model is that when an investor holds a foreign asset, he/she experiences a proportional deadweight loss. Cooper and Kaplanis (1994) compute point estimates of the implicit costs of foreign investments for a sample of eight developed countries, for different levels of relative risk aversion. Assuming a risk aversion parameter of, for instance, 2.5, they estimate that in 1987 the costs of inward investments were 2.85% p.a. for the U.S., 4.28% p.a. for France, and 12.65% p.a. for Spain. An important advantage of their methodology is that they only need the covariance matrix estimation to calculate the deadweight costs, thus avoiding the use of noisy realized returns as proxies for expected returns. Still, there are some drawbacks: (1) the Cooper and Kaplanis (1994) model does not account for nontraded assets or other asset holdings that are missing from the sample; (2) the obtained deadweight cost estimates are just point estimates, thus confidence intervals cannot be computed; (3) the model does not account for time-varying returns and variances; and (4) the deadweight-cost estimates are dependent on a postulated value for relative risk aversion. Sercu and Vanpee (2008) and De Moor, Sercu, and Vanpee (2010) generalize the model of Cooper and Kaplanis (1994) and use portfolio holdings data to solve some of the weaknesses of the original model. First, they use hedged stock returns to account for exchange rates and omitted markets. Second, they construct an expression that is independent of expected returns. Third, they apply a regression technique to the model such that confidence intervals can be computed for the average implicit investment costs, and that the risk aversion parameter can be estimated instead of postulated. Specifically, the deadweight costs of foreign investments are estimated by projecting the costs onto a set of instruments that have been proven to be correlated with home bias. These instruments are organized into six categories: information asymmetries, explicit frictions, measures for financial development, measures for economic development, measures for political risk and corporate governance, and the skewness in equity returns. Lastly, De Moor et al. (2010) use the time-varying volatility model of Bekaert and Harvey (1995) to estimate the covariance matrix of risky asset returns. This way, the model accounts for time-varying and asymmetric volatilities. Their methodology leads to foreign investment cost estimates for the developed countries that are much lower than the estimates of other authors. For the period 2001 to 2004, implicit inward investment costs are estimated to be 0.01% p.a. for the U.S. to 1.55% p.a. for Portugal, with relative risk aversion estimated at 1.25. For the emerging markets, the estimated implied costs are higher: from 2.15% p.a. for Brazil to 13.88% p.a. for Russia. The estimates of foreign investment costs obtained by De Moor et al. (2010) are lower and perhaps more plausible than those reported earlier by Cooper and Kaplanis (1994), but still the model is imperfect since it cannot account for nontraded assets such as human capital. An alternative method to calculate the costs of underdiversification is proposed by Lau, Ng, and Zhang (2010), who derive a relationship between the degree of a country’s home bias and its cost of capital. The model implies that the degree

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of the home bias induces a larger cost of capital if the country’s variance of equity return is greater than the country’s covariance of equity return with the world market portfolio. Empirical evidence shows that this is generally the case (Lau et al. 2007; Stulz 1999). Lau et al. (2010) show that their model can be easily extended to incorporate implicit investment costs as intended by Cooper and Kaplanis (1994). To estimate the cost of capital, Lau et al. (2010) consider three different approaches. First, they calculate the implied cost of capital using a price-to-earnings ratio divided by the earnings growth rate – the price/earnings to growth (PEG) ratio model, which is developed by Easton (2004). Second, they consider the realized return as an estimate of the expected return. Third, they calculate the expected dividend yield as a measure of the cost of capital. Their results show that countries that are more strongly home biased have a significantly greater cost of capital, even when ownership concentration, foreign investment costs, and other country-specific variables are taken into account. If, for instance, U.S. investors held the world market portfolio, their country’s cost of capital would drop with just 0.12%, while for Polish investors the reduction in the cost of capital would amount to 1.3%. Although these results are appealing, one should keep in mind that they are still fully dependent on an estimate for the expected return. Implied expected returns are better proxies for expected returns than realized returns, but still imperfect (Pastor, Sinha, and Swaminathan 2006). Also the model considers only equity holdings, thus fully ignoring other traded and nontraded assets, exchange rates, and inflation rates. Errunza, Hogan, and Hung (1999) show empirically that the estimated costs from underdiversification as calculated from a traditional mean-variance approach are overstated. They find that U.S. investors can mimic foreign market indices and achieve a portfolio that is internationally mean-variance efficient by using domestically traded multinationals, closed-end country funds, and American depositary receipts (ADRs). They find that the difference between the gains from a home-made diversified portfolio and a portfolio composed of shares trading abroad are statistically and economically insignificant. However, they also find that although the average gains from foreign-asset-based diversification are insignificant, there are periods when international markets provide a meaningful diversification that cannot be replicated at home. The study of Errunza et al. (1999) is carried out from the viewpoint of U.S. investors. Investors from other countries, especially emerging markets, probably have fewer opportunities to compose an internationally mean-variance-efficient portfolio using domestically traded assets. Diversification costs estimation based on a consumption approach As an alternative to the mean-variance portfolio theory approach, the implied costs of underdiversification can be calculated using a consumption-based approach that takes a production process as exogenously given and determines how optimal risk-sharing would affect the investor’s consumption path (Cole and Obstfeld 1991; Lewis 1996, 2000; Tesar 1993; van Wincoop 1994). The

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computed welfare gains from international risk-sharing under a consumptionbased framework are usually reported as the permanent percentage increase in expected consumption that leads to an equivalent increase in welfare. The reported results vary wildly depending on: (1) the implicit risk-free rate; (2) the risk-adjusted growth rate; (3) the rate of relative risk aversion; and (4) endowment uncertainty. van Wincoop (1999) has also contributed to this literature. Lewis (2000) uses data from 1969 to 1993 to calculate the gains from international diversification for a U.S. investor and compares the mean-variance portfolio approach with the consumption-based approach. She first calculates the efficient frontier – a combination of foreign and domestic stocks that results in a portfolio providing the highest expected return for any given variance of the return – and then calculates the gains from moving from the utility of a portfolio of 100% U.S. stocks to the utility of the portfolio at the efficient frontier. Using a mean-variance equity-based approach and fixing the parameter of relative risk aversion at 2, Lewis (2000) estimates that the gains from international diversification are in the range of 10% of current wealth to 28.8% of current wealth (depending on the level of intertemporal elasticity of substitution in consumption). For higher levels of relative risk aversion, welfare gains are even higher. Lewis (2000) compares these estimated welfare gains with the gains from diversification estimated from a consumption-based model. The gains for U.S. investors resulting from moving from autarky to an open economy, assuming again that relative risk aversion is equal to 2, are estimated in the range of 0.04% to 0.25% of total current consumption. Lewis (2000) reasons that the explanation for the difference in the estimated costs of underdiversification resulting from an equity-based mean-variance approach and a consumption-based approach lies in the high variability of stock returns compared to the low variability in consumption growth rates. The gains from international diversification derive from the benefits of reducing the variability of marginal utility over time. In the equity-based approach, marginal utility is assumed to depend on stock returns (which are implicitly assumed to drive consumption, but this link is ignored), while in the consumption-based approach, marginal utility is estimated from consumption. An important weakness of the consumption-based asset pricing model is that it works poorly in practice, even worse than the equity-based CAPM (Campbell and Cochrane 2000; Gordon and Samson 2002). Cochrane (1996) compares the mean excess returns of 10 Center for Research in Security Prices (CRSP)-size portfolios with the predictions of the consumption-based model and concludes that the consumption-based model does not do very well: the pricing error (i.e., actual expected return – predicted expected return) for each portfolio is of the same order of magnitude as the spread in expected returns across the portfolio. Another problem with the consumption-based model is that it is not only weak in fitting the data, but it also leads to levels for risk aversion that are too high to be plausible. For example, to obtain the best fit for the data, Cochrane (1996) had to impose a risk aversion parameter of 241. The underlying explanation may have to do with the fact that, even in the U.S., consumers’ spending is not

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closely tied to the stock market. Many do not hold stocks, others still derive most of their income from other sources, and even pure rentiers may be less sensitive to prices than theory predicts. Diversification costs estimation based on individual portfolio holdings In this approach, the costs from underdiversification are derived from data on individual portfolio holdings directly, instead of from a theoretical model. Goetzmann and Kumar (2004), using a large sample of individual portfolio holdings during the period 1991–1996, calculate the costs of underdiversification by organizing portfolios in groups based on the degree of diversification. Using CAPM tests and four-factor alphas, they find that the least diversified group of investors earn 2.4% lower annual return than the most diversified group of investors. This performance differential is not due to differences in turnover or transactions costs. Goetzmann and Kumar (2004) show that the degree of diversification is related to specific investor characteristics: the economic costs of underdiversification are higher for older investors and investors who trade infrequently. Within these two groups, the risk-adjusted performance differentials between the least diversified and the most diversified investors are 3.60% and 3.12%, respectively. Empirically, transaction costs in the narrow sense cannot be a reasonable explanation for the home bias. If trading in foreign assets is more expensive, one would expect a smaller amount of transactions in foreign assets than in domestic assets. However, Tesar and Werner (1995) find that the turnover rate on foreign equity is far higher than on domestic equity. Tesar and Werner (1995) calculate the turnover rate for three types of holdings of equities: domestic resident holdings of domestic equities, domestic resident holdings of foreign equities, and foreign resident holdings of domestic equities. While the domestic turnover rate averages less than one, the turnover rates for international equity flows is higher. Therefore, the flows of capital on international equity transactions tend to be higher than those on domestic flows. Significant restrictions on international transactions would suggest the opposite pattern. Although this evidence does not provide any standard errors, and therefore should be interpreted with caution, it suggests that international equity transactions are not significantly impeded among these countries. Indeed, cross-border equity flows have been quite large in recent decades. Data show the large magnitudes of these flows to and from various parts of the world. For example, in 1994, U.S. investors acquired 49 billion dollars of equity from abroad while foreigners bought only 1.8 billion dollars of equity from the U.S. Data also show tremendous volatility over time. Anecdotal evidence following the 1995 Mexican and 1997 Asian financial crises also suggest significant international movement in capital. If the costs of foreign investment are high, the size and variability of these flows are difficult to justify. Karolyi and Stulz (2003) report that the gross equity flows are very large compared to the net equity flows. For instance, in 1999, equity transactions between U.S. investors and foreign investors totaled $4.6 trillion. Further, during the first

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three quarters of 2000, U.S. investors bought foreign shares for $1.376 trillion and sold foreign shares for $1.364 trillion, buying a net amount of foreign shares of slightly more than $12 billion. The authors conclude that such dramatic gross purchases and gross sales seem hard to reconcile with the existence of important differential transaction costs for the purchase and sale of foreign shares compared to domestic shares. Amadi and Bergin (2008) and Rowland (1999) construct models that can generate higher turnover for foreign asset holdings than for domestic ones, in the former case with proportional trading costs, while in the latter case with fixed trading costs. Warnock (2002) re-examines Tesar and Werner’s (1995) finding, and concludes that foreign turnover rates are similar to domestic turnover rates, but transaction costs still fail as an explanation for home bias. Thus, direct costs do not offer a complete or even a major explanation for the home bias. Of course, costs of foreign equity holdings are in general difficult to assess since investors differ in terms of their relevant costs. Whatever the relevant costs, it seems likely that these costs have been declining over time. Many emerging market governments have reduced taxes and other restrictions on foreign investment. Indeed, a general liberalization in capital market restrictions has reduced the taxes to foreign investments for residents in most industrialized countries as well. Furthermore, increased competition in the mutual fund industry has reduced the cost to domestic residents of investing in foreign and international mutual funds. As a result, these costs are generally perceived to be declining over time and, at any rate, it is difficult to argue that they exceed the potential benefits of diversification. Thus, the argument that costs exceed the gains does not appear plausible, at least for diversification into developed countries. Ahearne et al. (2004), Domowitz, Glen, and Madhavan (2001), and Warnock (2002) have confirmed that measurable transaction costs do not help explain the observed home bias. An alternative cost of foreign investment is the cost to domestic residents of acquiring information about foreign equity markets (Brennan and Cao 1997; Coval and Moskowitz 2001; Gehrig 1993; Vissing-Jorgensen 2004). Equity investment in foreign companies that are not cross-listed in domestic markets requires understanding of foreign accounting practices and corporate relationships, not to mention the legal environment. Some indirect evidence points to the importance of these informational costs. For example, Kang and Stulz (1997) find that foreign investors primarily invest in stocks of Japanese companies that are better known to foreign investors, even when the expected returns are lower than returns on other Japanese stocks. Leblang (2010) argues that diaspora networks – cultural and/or familial linkages between migrant communities in the investing country and the migrant’s country of origin – play a pivotal role in the global allocation of capital (e.g., Greif 1989; North 2005) and reducing the home bias. The hypothesis is that diaspora networks – connections between migrants residing in investing countries and their home country – influence global investment by reducing transaction and information costs. This hypothesis is tested using dyadic cross-sectional data for both

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portfolio and foreign direct investment (FDI). The findings indicate that, even after controlling for a multitude of factors, disapora networks have both a substantively significant effect and a statistically significant effect on cross-border investment. Leblang’s (2010) idea is related to “international relations theory” (e.g., Greif 1989, 1993; Keck and Sikkink 1998; Keohane and Nye 1974; Shain and Barth 2003; Sheffer 2003; Slaughter 2004); to “cultural affinity” theory (e.g., Guiso, Sapienza, and Zingales 2009; Siegel, Licht, and Schwartz 2011); and “economic sociology” (e.g., Bandelj 2002, 2007; Granovetter 1973; Uzzi 1996). He argues that the existing literature on investment is primarily monadic, emphasizing the importance of credible commitments and institutional quality in the countries that seek global capital. Alfaro, Kelemli-Ozcan, and Volosovych (2006), Buthe and Milner (2008), and Jensen (2003) have also contributed to this literature. Leblang (2010) explains that migrant networks foster a greater degree of familiarity between home and host countries than may occur in their absence. Just as migrants may have a taste for commodities produced in their home country, they may also have a preference for home country investments – leading them to invest money in their country of origin (Choi 2003; Lueth and Ruiz-Arranz 2006; Ratha and Shaw 2007; Saxenian, 2002, 2006). Diaspora networks can also help decrease asymmetries of information that, from the perspective of the theory of portfolio investment, can result in a less than optimal portfolio. The reduction in information asymmetries works through two channels. First, migrant communities in destination countries can provide investors with information about their homeland – information regarding the tastes of consumers in their country of origin – that can influence the decision of investors to invest there. Second, diaspora networks can have an indirect effect on investment because they may have knowledge about investment opportunities, information about regulations and procedures, or familiarity with language and customs that can decrease the transaction costs associated with cross-border investment. Examples include: Freinkman (2002) on Armenia; Gould (1994) on the United States; Head and Reis (1998) on Canada; Kapur (2001) and Saxenian (2002) on India; Kleinman (1996) on Israel; Rauch and Casella (2001) and Weidenbaum and Hughes (1996) on China; Schulte (2008) on Turkey; and Schuttler (2007) on Morocco. Taken together, the evidence suggests that government restrictions and information costs can be important for explaining why the portfolios of domestic residents in developing, relatively unrestricted countries may be biased away from holdings of equities in emerging markets. On the other hand, this argument is more difficult to make for the equities of developed countries that do not face these restrictions. As has been noted, the U.S. demonstrates a strong “home bias” in equity holdings with developed countries such as Germany and the U.K., yet these countries do not impose significant restrictions on capital account movements. Moreover, the costs of acquiring information on at least some firms in these countries do not appear large, particularly for institutional investors and for foreign stocks that are traded in the U.S., the so-called ADRs.

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Some authors have argued that the benefits of international diversification might not be sufficiently clear to justify moving away from a local default position. These authors have adhered to the following two approaches. The first approach is to gauge if locally available assets offer sufficient diversification to render international diversification as redundant (“spanning” tests). That is, this approach argues that the diversification potential from foreign equities is already contained in domestic equities. Thus, U.S. investors do not need to hold foreign stocks to gain the benefits of foreign diversification. The contention that locally available assets may suffice seems to be supported for the U.S., where there is access to a wide range of multinational companies, country funds, and listed international assets via ADRs. For instance, the U.S. has many large multinational firms, and these firms have foreign operations, and thereby provide the equity holder with returns that depend upon foreign economies (Errunza et al. 1999). However, this is clearly a tenuous proposition for smaller countries with a narrow universe of available investments. It should be noted that the stocks of multinationals usually move quite closely with their respective national market indexes. Indeed, studies have shown that the betas of these stocks with respect to their own markets are usually relatively close to one. Therefore, the multinationals provide little better diversification than the domestic market. Lewis (1999) and Rowland and Tesar (2004) argue that the correlation between the returns of multinational and their national stock indices is quite high, thus limiting the diversification benefits they can actually offer. Heston and Rouwenhorst (1994) and Jacquillat and Solnik (1978) provide some evidence for the importance of national factors. Many multinational firms are important components of the domestic stock market index. Therefore, the low correlation between these indexes and foreign stocks must arise from the importance of foreign stocks themselves, not multinational stocks that are correlated with the domestic index. The international diversification gains require holdings of foreign assets that are not a part of the domestic index. Bekaert and Urias (1996) use an estimation approach that examines whether the sources of uncertainty contained in foreign returns are captured or “spanned” by domestic returns. In particular, they examine the gains from the point of view of U.S. and U.K. domestic investors of holding closed-end mutual funds invested in foreign countries. They find that these country funds are spanned by the U.S. market and, hence, cannot reject the hypothesis that there are no gains to foreign investment for Americans. This same hypothesis is rejected for the U.K. Thus, the Bekaert and Urias (1996) results would seem to suggest that home bias can be explained by spanning for the residents of the U.S., but not the U.K. Antoniou, Olusi, and Paudyal (2010) examine whether British investors need to diversify their portfolios internationally to gain performance benefits from international markets, or can obtain these benefits by mimicking the portfolios with domestically traded assets. Their results confirm that it is possible to mimic the performance of foreign equity with domestic equity. Indeed, the pay-offs from homemade portfolios outperform those from international portfolios

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regardless of the periodic variation in the overall performance of the U.K. market vis-a-vis foreign markets. The superiority of homemade portfolio is more prominent in recent years and is enhanced by the increased internationalization of developed capital markets. They conclude that investors’ home bias is not suboptimal. The second approach involves evaluating international exposure relative to a local benchmark, and establishing that international diversification offers insignificant benefits within usual confidence intervals after allowing for estimate uncertainty. Gorman and Jorgensen (2002), Herold and Maurer (2003), and Li (2004) have contributed to this literature. This view comes from incorporating empirical uncertainty into the analysis. Note that in the finance literature, the gains from international diversification are calculated from measures of the expected returns and their variances. These measures are typically derived from historical means and variances of returns. However, data demonstrate that the mean returns for different markets are quite volatile. Indeed, casual inspection would suggest that the mean of the U.S. market is not statistically significantly different from the other equity markets. In particular, the mean and standard deviations on the U.S. market are 11% and 15%, respectively, while the same mean and standard deviations on the EAFE fund are 12% and 17%. The evidence suggests that while portfolio points corresponding to 100% domestic equity and 100% foreign equity imply different means and variances, the hypothesis that they are not statistically different cannot be rejected. Indeed, the hypothesis that the mean returns are equal to zero cannot be rejected either. Therefore, it would seem necessary to examine the degree of uncertainty in the estimates of the mean returns as well as the variances of returns, to determine whether home bias really does exist. The original literature on international portfolio choice establishes that investors should benefit from international diversification through a shift in the efficient frontier (Levy 1980; Solnik 1974a). Bekaert and Urias (1996), De Santis (1995), and De Santis and Gerard (1997) conclude that shifts in the efficient frontier are not statistically significant. Britten-Jones (1999) and Errunza et al. (1999) show that these results are robust to the inclusion of emerging markets. Gorman and Jorgensen (2002), in a similar spirit, find that observed portfolio allocation weights are not statistically significantly different from an optimal allocation. They examine optimal portfolio allocations from the point of view of residents in each of the G-5 countries (U.S., U.K., Germany, France, and Japan). Their in-sample tests reveal that the optimal portfolio is not significantly different from a 100% domestic portfolio (i.e., extreme home bias). Their out-of-sample tests, with a view toward investment performance, reveal that typically, a 100% domestic portfolio outperforms the optimal portfolio. Their findings are robust to a variety of plausible investment strategies and statistical methodologies. They conclude that the theorized benefits from international diversification appear difficult to capture in practice and, hence, investors exhibiting a strong home bias are not necessarily acting irrationally.

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Bekaert and Wang (2009) find that the old empirical results based on the U.S. data alone do not generalize to their panel data set. According to the evidence suggested above, there may be no home bias because foreign diversification does not lead to a statistically significant improvement in portfolio performance. On the other hand, examinations of statistical significance by the econometrician as performed in these studies lead to other questions such as: what does the investor do when confronted with estimation errors? If he/she cannot reject the null hypothesis of no improvement in diversification, does he place all of his portfolio in domestic assets alone? And if he/she rejects the null hypothesis, does he/she treat the point estimates of means and variances as the truth in determining his portfolio allocation? Bayesian portfolio analysis provides a framework for answering these questions (Klein and Bawa 1976). In this framework, the investor has prior views about means and variances of returns, updates those views as he/she observes new data and then makes a portfolio allocation decision. Pastor (2000) has applied Bayesian portfolio decisions to the home bias question. Specifically, Pastor examines the case of a U.S. investor who must decide between U.S. and foreign equity markets. Before looking at the data, the investor believes that the risk-adjusted mean of foreign returns in excess of domestic returns is zero. This investor could be viewed as one whose prior beliefs are that he/she can do no better than the domestic market. Pastor (2000) then considers how the portfolio allocation of this investor into foreign equities will change as his/her prior views on the variability of these returns increase. While the standard deviation of foreign risk-adjusted excess returns in the data exceeds 3% per annum, Pastor (2000) finds that the investor’s prior view about the distribution must be no greater than 1% per annum to explain U.S. home bias. Moreover, an investor with diffuse views about foreign returns would place 47% of his/her portfolio in foreign equities, far exceeding the observed share of 8%. The investor may choose a strongly home-biased portfolio if he/she holds a strong biased prior toward the domestic asset. But greater uncertainty on foreign stock returns can induce him/her to pay more attention to the data and move away from this prior. Pastor (2000) concludes that within this rational behavior framework, the extent of the observed home equity bias can only be explained by very strong prior beliefs in the domestic CAPM-equivalent to a maximum mispricing of the foreign stock portfolio of 2% per year. Li (2001) extends the analysis of Pastor (2000) to consider several foreign markets and investor’s beliefs about both risk and returns of foreign stocks. Li’s (2001) results confirm that investors must have very strong priors about the higher risk or lower returns of foreign stocks, and she concludes that her results are consistent with the behavioral explanation of the home bias puzzle. Thus, a Bayesian approach that incorporates estimation risk into the portfolio analysis suggests that difficulties in empirical measurement do not necessarily explain home bias. Indeed, greater uncertainty about foreign returns may induce the investor to pay more attention to the data and allocate more of his/her wealth to foreign equities.

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Another literature has stressed that return correlations tend to increase in bear markets, when it would be most important to diversify risks (Lin, Engle, and Ito 1994). Thus, the potential benefits of international diversification could be lower than is commonly thought. On the other hand, the gains from the international diversification of stock portfolios appear to be large. Athanasoulis and van Wincoop (2000), Grauer and Hakansson (1987), Levy and Sarnat (1970), Lewis (2000), and van Wincoop (1994, 1996, 1999) have contributed to this literature. Just to get a sense of the extent of the international diversification benefit, as noted above, Lewis (1999) reports that during 1970–96 the correlation between the monthly returns on the USA and EAFE stock market indices was 0.48 only. This modest correlation implies an allocation of at least 40% of the U.S. investors’ portfolio to foreign stocks. This should be compared to the actual U.S. allocation to foreign stocks of 8% only. Lewis (2000) estimates that the gain to an investor from international diversification can amount to 100% of her lifetime consumption. This means that international diversification gains exceed costs, implying that costs can, at best, explain only part of the home bias puzzle. Overall, there seems to be a consensus that the gains from international diversification can be substantial and that the extra cost of international diversification is not cardinal. French and Poterba (1991) contend that for most investors there is little difference between the foreign and domestic tax burdens. Therefore, the observed preference for domestic equity is even more puzzling.

1.3 Information asymmetries One of the potential explanations for home bias is that the preference for domestic assets is driven by information asymmetries between domestic and foreign investors. Indeed, if there is differential information, risk-averse investors prefer the stocks on which they easily have better information – these are typically thought to be the domestic stocks. Informational friction plays an important role in international investments. The role of information has been extensively investigated in the finance literature, but less so in the open financial macroeconomics literature; of course, Dumas, Lewis, and Osambela (2017), Hatchondo (2008), and Tille and van Wincoop (2009) are notable exceptions. The impact of informational asymmetries on portfolio decisions was initially studied in the finance literature. In contrast to standard DSGE macro models, the finance literature relies on some partial equilibrium assumptions: stock returns characteristics (risk and expected returns) are exogenously given and the riskfree asset is in infinite supply. In this literature, domestic and foreign investors differ on their (exogenously given) information sets regarding future domestic and foreign stock returns. The hypothesis that foreign investors are less well-informed about domestic stocks forms the starting point for several theoretical models. Gehrig (1993) and

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Brennan and Cao (1997) develop a simple two-country noisy rational expectations model with one stock per country. They assume that agents in each country receive a signal on the future performance of each stock, but the signal on the foreign asset is less precise. Hence, domestic investors perceive the foreign stock as riskier and reduce their foreign stock holdings, which leads to equity home bias. Moreover, Brennan and Cao (1997) show that less well-informed foreign investors respond more strongly to public signals on domestic stocks conveyed by stock prices. Hence, foreign investors buy more of the domestic stocks when the domestic market performs well. The authors find evidence for this “return-chasing” effect in the data. Barron and Ni (2008), Hasan and Simaan (2000), Lundtofte (2009), and Portes, Rey, and Oh (2001) have also contributed to this literature. Brennan et al. (2005) develop a noisy rational expectations model where investors receive public and private information signals, with the private signal being less precise for foreign investors. They confirm the results from earlier work by Brennan and Cao (1997), who show empirically that foreign purchases of U.S. investors are positively correlated with the lagged foreign market returns. This is consistent with U.S. investors being at an information disadvantage relative to foreign investors. Additionally, Brennan et al. (2005) show that there is a link between information disadvantages and the expectations (degree of bullishness) about a market: foreign investors tend to become more bullish about a certain market following a positive return on that market. Kang and Stulz (1997) provide some evidence about holdings of foreign assets that is consistent with an information advantage for domestic investors. They show that Japanese firms with a greater “international presence” – as evidenced by having ADRs, or a great deal of export business – have greater foreign ownership. In other words, foreign investors in Japan hold more stocks of large companies than they do of small companies. That is, the home bias is stronger for small stocks than for large stocks. One would expect that the information disadvantage of foreign investors would be smaller for large stocks (Bradshaw, Bushee, and Miller 2004; Covrig, Defond, and Hung 2007; Edison and Warnock 2004; Kho, Stulz, and Warnock 2009; Mankiw and Zeldes 1991). Dahlquist and Robertson (2001) investigate the holdings of Swedish stocks by nonresident investors. Their results are consistent with Kang and Stulz (1997). They point out that non-resident investors are mostly institutional investors, and that the holdings of stocks by nonresident investors exhibit biases that are also typical of resident institutional investors. Glassman and Riddick (2001) quantify what should be the perceived riskiness of foreign assets (due to lower information quality) in order to generate the observed home bias of U.S. investors. They find that investors would have to scale up standard deviations of returns by a factor from 2 to 5 depending on risk aversion, and conclude that these scaling factors are implausibly high. Albuquerque, Bauer, and Schneider (2007) solve their model for international equity flows when a set of home and foreign investors have superior information. They argue that this informational heterogeneity within the foreign set of

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investors is more important than informational heterogeneity across countries to explain international equity trades. In line with the data, their model explains why (1) U.S. investors trade in waves, with simultaneous buying and selling; (2) U.S. investors change their foreign equity positions gradually; and (3) U.S. investors increase their equity position in a country following a rise in its stock price. Balduzzi and Liu (2004) move some steps towards an explanation of the home bias based on Bayesian learning. However, their study is limited to the investigation of the partial-equilibrium problem of an agent who learns the mean return vector. Guidolin (2005) develops a two-country overlapping-generations model under the assumption that investors are on a learning path. While investors from both countries receive identical information flows, domestic investors start off with less precise prior beliefs concerning foreign fundamentals. On a learning path, differences in beliefs and estimation risk generate portfolio biases that match the empirical evidence: home bias in equity. Coval (1999) uses an infinite horizon equilibrium model in which agents can only obtain noisy observations on fundamentals abroad. When calibrated on the U.S. economy, (one of) the resulting rational-expectations equilibria is characterized by home equity preference, although the effects are small and strongly dependent on parameters that are hard to calibrate, such as the degree of information asymmetry. The finance literature described above has had an impact on more standard general equilibrium macro models along the lines of the open economy financial macroeconomics approach, which are discussed in this and the next paragraph. Hatchondo (2008) builds a single-good two-country model and two assets per country with two departures from standard models. Firstly, he assumes that only local investors receive informative signals about local assets. This informational advantage induces agents to invest in the good local asset. Secondly, engaging in short selling is assumed to be costly. When the signal is sufficiently informative and short selling costs are high enough, agents do not sell the bad local asset short in order to invest more in the good local asset, but rather reduce their holdings of foreign assets. This leads to equity home bias in equilibrium. Gordon and Bovenberg (1996) present a small open economy model where home bias results from information asymmetries, which decrease the return home investors get on their foreign capital investment. In such a setup, subsidizing capital imports is optimal. Razin, Sadka, and Yuen (1999) assume that domestic investors can observe the productivity of domestic firms before making their loan decisions, while foreign investors cannot. This results in foreign underinvestment and domestic over-saving. Building on a similar asymmetric information set-up but adding the possibility of liquidity shocks, Goldstein and Razin (2006) study the trade-off between FDI and portfolio investment, the latter being more liquid than the former. Tille and van Wincoop (2009) apply the noisy rational expectations framework from the finance literature to a standard two-country/one-good DSGE

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model. They depart from standard open macro models by introducing information dispersion across investors. Each investor receives a private signal on the future fundamentals (productivity) of domestic and foreign stock, the signal on its own stock being more precise (as in Gehrig 1993 and Brennan and Cao 1997). The noise is introduced in the form of (unobserved) stochastic transaction costs to invest abroad which generates portfolio shifts toward or away from foreign assets. This makes sure that stock prices cannot fully aggregate private signals in equilibrium. These transaction costs generate equity home bias in equilibrium, but this is not the purpose of the paper. They show that dispersed private information disconnects not only stock prices from the currently observed fundamental values, but also international capital flows (gross and net). Moreover, capital flows should help forecast future fundamentals. They find some empirical support for their results. The early noisy rational expectations literature when applied to international portfolio choice relies on exogenous information structures. A challenge has been to extend it by allowing for endogenous information acquisition. In this line of research, information is a tool to reduce the conditional variance of the asset payoffs. Using a model of rational inattention introduced by Sims (2003), van Nieuwerburgh and Veldkamp (2009) build a model where a tiny information advantage is enough to generate significant home bias if investors have a limited capacity to process information. In this model, agents are endowed with a small informational advantage on the local asset, which lowers its perceived riskiness. Thus, the investor will tend to hold more of the local asset. However, this effect is amplified as the more of an asset the agent owns, the more attractive it becomes to learn about the asset. Endogenous and costly acquisition of information amplifies the initial small informational advantage and leads to specialization in local stocks. Learning turns out to amplify information asymmetries instead of reducing them. In their set-up, countries which are learnt about a lot by investors should have lower returns compared to the prediction of a standard CAPM model, as lower uncertainty goes hand-in-hand with a lower return. van Nieuwerburgh and Veldkamp (2010) apply variations of their rational inattention model to explain investment strategies of investors, by varying the specification of the preferences or of the information constraint that they face. Depending on the convexity of the objective function of investors, they can rationalize concentrated or diversified portfolios. De Marco, Macchiavelli, and Valchev (2017) have also contributed to this literature. Mondria (2010) allows rationally inattentive investors to decide not only on the precision, but also on the structure of the information they process. In equilibrium, agents choose to learn not only about individual assets but also about linear combination of assets, i.e., indices. Such a learning strategy makes sense as the structure of the signal the agents choose in equilibrium depends on their objective function. Since investors will choose to hold a somewhat diversified portfolio in equilibrium, they choose to process information about combinations of assets (they are interested not only in the volatility of each asset, but also in their covariance). Mondria and Wu (2010) use a similar

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framework to explain the time series of home bias. When financial liberalization took place in the developed economies in the 1980s, investors started to be able to diversify their portfolios and home bias decreased, but only gradually, as investors have an initial information advantage on domestic assets. The authors show that the persistence of asset pay-offs and increases in the information processing capacity tend to magnify home bias. By looking at the interaction of capital markets openness and learning strategies, they are able to reproduce the time series of home bias. Mondria and Wu (2013) show that informational advantages may arise endogenously as a response to the presence of small financial frictions, even if initial information is assumed to be symmetric. Imperfect international financial integration imposes small transaction costs or tax disadvantages on holdings of foreign assets, which leads investors to tilt their portfolios towards domestic assets. Because local assets now represent a larger share of investors’ portfolios, investors naturally process more information about local assets, thus endogenously generating a small informational advantage. This small endogenous informational advantage is then magnified into large informational asymmetries and large levels of home bias through feedback between portfolio and attention allocation choices: as domestic investors become better informed about domestic assets, they optimally decide to hold even more of such assets and, therefore, process even more information about them. The authors also present empirical evidence supporting their model’s main predictions. Dziuda and Mondria (2012) propose a model of delegated asset management that can explain the following empirical regularities in international markets: the presence of home bias, the lower proportion of mutual funds investing domestically, and the higher market value of mutual funds investing domestically. Zhou (1998) shows that a multi-asset intertemporal general equilibrium with differential information can explain a bias to domestic equities. With differential information, agents on average tilt their portfolios towards stocks that they have better information about, because the better information results in lower conditional variances of stock returns. The question left unanswered by the theory is whether the costs of reducing this information asymmetry are really large enough to prevent intermediaries trying to exploit the well-known benefits of international diversification. Many studies examine the link between information asymmetries and international portfolio choices by regression. Actual portfolio holdings (or, often, differences between actual portfolio holdings and optimal portfolio holdings based on an international asset pricing model) are regressed directly on variables that proxy for information asymmetries such as regional and cultural factors (Berkel 2007; Chan, Covrig, and Ng 2005; Faruquee, Lee, and Yan 2004; Lane and Milesi-Ferretti 2005, 2008). Foreign investors could be disadvantaged because of distance, because of differences in language and culture, and because of time-zone differences. Their main findings are briefly discussed below. The proximity of the foreign market is a dominant factor to capture the effects of information asymmetries in portfolio choice problems. There is evidence that

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distance matters. Portes and Rey (2005) focus on international equity flows and find that the physical distance between two countries has all the symptoms of being a proxy for information asymmetries. They show that physical distance affects international equity flows and holdings very significantly: doubling the distance reduces cross-border equity flows by half. The role of distance in financial decisions is not restricted to international equity or bond investments. Coval and Moskowitz (1999) study the behavior of mutual fund managers in the U.S. who exhibit a strong preference for locally headquartered firms, particularly small firms that produce nontraded goods, illustrating a local bias. Coval and Moskowitz (1999) find that U.S. mutual fund managers prefer to invest in nearby firms even within a country. Coval and Moskowitz (1999, 2001) show that the weight of a U.S. stock in U.S. mutual funds is negatively related to the distance between the location of the fund and the location of the headquarters of the firm, and that mutual fund managers do better with their holdings of stocks of firms located more closely to where the mutual fund is located. Coval and Moskowitz (1999) find that the average U.S. fund manager invests in companies that are between 160 and 184 kilometers (or 9% to 11%) closer than the average firm in the market portfolio (Hong, Kubik, and Stein 2005; Parwada 2008). In a study on Finnish investors, Grinblatt and Keloharju (2001) document that Finnish investors are more likely to hold, buy, and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor’s native tongue, and that have chief executives of the same cultural background. The idea of an information advantage for investors who are physically close to the investment opportunity is enforced by the fact that those investors seem to obtain higher returns than investors located further away. Coval and Moskowitz (2001) find evidence that fund managers who display a stronger local bias achieve higher risk-adjusted returns, and interpret their results as evidence that information advantages motivate investors to favor nearby investments. Grote and Umber (2006) show that the local bias also exists in U.S. merger and acquisition decisions, and that the most successful mergers and acquisitions deals are the ones that display a stronger local bias. Petersen and Rajan (2002) study the effect of distance on lending relationships. Apparently, being in close proximity to a firm means that investors do have access to more, or more accurate, information about the firm. Tesar and Werner (1992, 1995) show that U.S. investors exhibit a bias towards Canadian stocks in their foreign investment. Huberman (2001) observes that Regional Bell Operating Companies (RBOCs) are more likely to be held by investors who subscribe to their local telephone service. He documents a substantial home bias in claims held by U.S. investors on RBOCs. Schultz (1996b) reports, based on a 1996 survey of 246 companies, that 43% of money invested in defined contribution plans is held in employer stock. Athanasoulis and van Wincoop (2001) find that the standard deviation of dividend income of state residents is only slightly lower than the standard deviation of state profits. Home bias at home has also been reported by Benartzi (2001), Feng and Seasholes (2004), Huberman and Sengmuller (2004), and Massa and Simonov (2006). For a review of this literature see Huberman (2000). They all interpret distance as a proxy for information asymmetries.

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Ivkovic and Weisbenner (2005) use data on the investments a large number of individual investors made through discount brokers from 1991 to 1996, and find that households exhibit a strong preference for local investments. They test whether this locality bias stems from information or from simple familiarity. They found that the average household generates an additional annualized return of 3.2% from its local holdings relative to its nonlocal holdings, suggesting that local investors can exploit local knowledge. Excess returns to investing are even larger among stocks not in the S&P 500 index, that is, firms for which information asymmetries between local and nonlocal investors may be largest. Aviat and Coeurdacier (2007) revisit the impact of distance on cross-border equity holdings (and bank loans). They find that the impact of distance is drastically reduced once it is controlled for bilateral goods trade: countries’ portfolios are strongly biased toward trading partners (see also Lane and Milesi-Ferretti 2008). Using instrumental variables, they show that the causality goes essentially one way: reducing barriers to trade in goods enhances crossborder asset holdings. However, one cannot reject the role of goods trade in fostering information flows across borders. Since a lot of information on stocks comes through the accounts of firms, it is to be expected that different accounting standards would act as information barriers. Bradshaw et al. (2004) find that firms exhibiting higher levels (changes) of U.S. generally accepted accounting principles (GAAP) conformity have greater levels (changes) of U.S. institutional ownership. This positive relation holds regardless of a firm’s visibility to U.S. investors (e.g., ADR listing, stock index membership, analyst following, firm size). Guiso and Jappelli (2006) use survey data on Italian investors, and find that investors who spend more time to acquire information also tend to hold less diversified portfolios, as implied by models of endogenous information acquisition. Hamberg, Mavruk, and Sjogren (2013) document that after the Swedish mandatory adoption of the International Financial Reporting Standards (IFRS), foreign ownership of Swedish firms has increased. The increase is driven by investors from countries that had already adopted IFRS, and particularly those from the European Union (E.U.). These effects are likely to have stemmed from an improved ability to compare firms across Europe, and are particularly strong in small firms. Decomposition for investor type reveals that foreign institutional investors increased their ownership stake after the mandatory IFRS adoption, whereas foreign non-institutional investments were not affected significantly by the IFRS adoption. In contrast to ownership from non-adopting countries, ownership from the E.U. increased in both intangible asset-intensive firms and firms with fewer intangible assets. Similarly, after the adoption, foreign ownership from the E.U. increased in firms with both concentrated ownership and dispersed ownership. Merton (1987) develops a model where investors hold stocks that they know. Such a model would be equivalent to one where investors think that the risk of stocks they do not know is extremely high. With that model, one would also see investors overweight domestic stocks. Strikingly, Ahearne et al.

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(2004) find that the most important variable in explaining the underweighting of stocks of various countries by American investors is the fraction of a country’s market capitalization that corresponds to firms with ADR programs: The greater this fraction for a country, the greater the weight of that country in the portfolio of U.S. investors. That is, U.S. holdings of foreign equities are significantly biased toward countries that have a higher share of their stock market listed on U.S. stock exchanges. The impact of ADR programs might be due to the fact that having a foreign stock traded in the U.S. represents a certification effect and reduces information asymmetries because of the adoption of U.S. GAAP. Ahearne et al. (2004) find that the impact of ADRs comes from listings that require firms to use U.S. GAAP and to provide Securities and Exchange Commission disclosures as opposed to over-the-counter listings. At the same time, however, an ADR program makes firms known, especially when it involves listing on an exchange, which would be supportive of Merton’s model. The empirical evidence on ADR programs (as surveyed by Karolyi 1998) shows that there is a positive abnormal return when a firm announces or lists an ADR program (Foerster and Karolyi 1999; Miller 1999); that ADR programs experience a pre-listing stock price run-up and post-listing stock price decline (Foerster and Karolyi 1999, 2000); and that global factors affect the pricing of ADR firms more than firms from the countries of ADR firms that do not list in the U.S. (Mittoo 1992; Karolyi 1998). This evidence is consistent with the hypothesis that a U.S. listing reduces some barriers to international investment. From 1994 through 2000, the size of ADR programs increased dramatically and it became markedly easier for U.S. investors to get exposure to foreign stocks, but with little impact on portfolio allocations. It is plausible that the success of the U.S. stock market led U.S. investors to keep their allocation to that market high, so that momentum trading explains why the home bias has not decreased. However, this explanation for why the home bias of U.S. investors has not decreased makes it even more puzzling why the home bias of foreign investors is so large. Cultural differences such as speaking a different language or having a different religion can also affect international portfolio choices: information costs occur under the form of translations and adaptation to different cultural or religious habits. Grinblatt and Keloharju (2001) show that, in Finland, language matters in an investor’s portfolio allocation. As noted above, Finnish investors whose native language is Swedish are more likely to own stocks of companies in Finland that have annual reports in Swedish and chief executive officers who speak Swedish than those investors whose native language is Finnish. Several studies show that there is also a size bias. Faruquee et al. (2004) and Sercu and Vanpee (2008) show that (log) GDP or the number of publicly listed companies significantly influences international portfolio holdings. This can be explained by the fact that information on large economies and stock markets is more universally widespread than information on small markets. Chan et al. (2005) find that stock market development and familiarity variables have a significant impact on home bias for a sample of mutual funds in 26 developed and developing markets. They aggregate the investments of these funds at the country level. Sarkissian and Schill

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(2004) show that, apart from geographical and cultural proximity, industrial (economic) proximity also plays an important role: overseas listing decisions of firms reflect investment decisions of investors, since cross-listing activity of firms is more common in markets that are geographically, culturally, and industrially proximate. Similarly, Coval and Moskowitz (1999) suggest that “economic distance” – as measured by, for instance, air fares or phone rate data – may be a good proxy for information asymmetries between domestic and foreign investors. Most models of information asymmetries imply that domestic investors should earn a higher return than foreign investors. However, the empirical evidence on this matter is mixed. Choe, Kho, and Stulz (2005), Coval and Moskowitz (1999), Dvorak (2005), and Hau (2001) find that domestic investors do in fact earn higher returns, while Grinblatt and Keloharju (2000) and Huang and Shiu (2009) find the opposite. More specifically, Hau (2001) using German data, Dvorak (2005) using Indonesian data, and Choe et al. (2005) using Korean data find that domestic investors realize higher profits than foreign investors. Hau (2001) finds that proprietary trades on the German stock market do better when they are geographically closer to Frankfurt. Choe et al. (2005) find evidence that foreign investors buy at higher prices than resident investors in Korea, and sell at lower prices. They, therefore, conclude that foreigners have an information disadvantage relative to domestic investors. There is, however, some evidence that conflicts with the view that foreign investors are less well-informed about domestic stocks. Grinblatt and Keloharju (2000), Huang and Shiu (2009), Karolyi (2002), Seasholes (2000), Seasholes and Zhu (2010), and Shukla and van Inwegen (1995) provide evidence that foreign institutional investors outperform residents. Grinblatt and Keloharju (2000) use Finnish data to show that, over their sample period, foreign investors are better at picking Finnish stocks than domestic investors. Seasholes (2000) shows that in Taiwan, foreign institutional investors buy stocks before positive earnings announcements and sell stocks before negative earnings announcements. Both papers argue that foreign institutional investors do better because they are more skilled at acquiring and interpreting information. Karolyi (2002) shows that foreign investors in Japanese equities outperformed Japanese individuals and institutions, including banks, trusts, and life insurance companies, as well as corporations, during the Asian financial crisis period. Huang and Shiu (2009), using data on equity investments in Taiwan, find that foreign investors – often professionally managed funds or investment banking houses – outperform domestic investors. Shukla and van Inwegen (1995) show that U.K. money managers underperform American money managers when picking U.S. stocks. Although there seems to be no real consensus on whether domestic investors outperform foreign investors, the empirical evidence of superior performance by domestic investors is more convincing. The studies which find that foreign investors achieve higher returns recognize that this is the case because foreign investors are mainly professionals who are more experienced and are professionally closer to the market than (domestic) households.

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There are some difficulties with the assumption of asymmetric information as an explanation for home bias. If investors have better or more information on domestic assets, they not only face a lower variance of domestic equity returns, but also their expected returns should often differ from those of foreign investors. This difference in expected returns depends on whether domestic investors observe a signal indicating high or low returns on domestic stocks. Thus, at least in some episodes, informed investors would have to hold fewer domestic stocks than foreigners do, notably if the information indicates a sufficiently low expected return. However, according to Jeske (2001), this investment behavior is in contrast to actual portfolio holdings, which indicate a continued home bias over decades in all countries. Another problem with the information-based explanation of home bias is the existence of many index vehicles through which the information disadvantage relative to foreign investors can be largely avoided. Errunza et al. (1999) show empirically that the benefits from an internationally diversified portfolio can be obtained by combining domestically traded multinationals, ADRs, and closed-end country funds in the portfolio. Similarly, Brealey, Cooper, and Kaplanis (1999) argue that institutional investors can hold country index funds or index futures combined with cash which deliver a return that avoids many of the institutional disadvantages associated with holding individual foreign equities. The question, therefore, remains why investors do not exploit these opportunities. Another criticism on information asymmetries as an explanation for home bias is that it makes the implausible assumption of information immobility, whereas asymmetric information should disappear when information is tradable. That is, domestic investors are free to learn about foreign firms. Such crossborder flows could potentially undermine the home bias. In short, when investor can choose which information to collect, initial information advantages could disappear. van Nieuwerburg and Veldkamp (2009) refute this criticism by showing theoretically (as discussed above) that a tiny information advantage is sufficient to create significantly home-biased portfolios if investors are restricted in the amount of information they can learn about. However, exponential progress observed in the information technology sector in the past decade has allowed local information to be accessed globally in essentially real time and at a very low cost. Therefore, assumptions about the degree of informational immobility that have to be made in order to generate the current levels of home bias seem implausibly high. While one could argue that, at the end of the 1980s, international capital markets were far from being frictionless, and this could contribute to rationalize home bias, this line of explanation seems more doubtful today. Despite increased financial integration, the equity home bias remains a pervasive phenomenon across countries and across time. The home bias in developed countries, across regions of the world, has decreased over the past few decades with the process of “financial globalization,” but remains high in most countries.

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1.4 Risk aversion instability Babilis and Fitzgerald (2005) find that, contrary to the conventional assumption that risk aversion is both relatively low and stable over time (canonized in neoclassical theory by the derivation of constant relative risk aversion from the utility function itself), it is, in fact, time-variant and path-dependent, which leads to fluctuating home bias.

1.5 Corporate governance and transparency Some studies have suggested that corporate governance and transparency on the firm level and political risk on the country level can also be a driver for equity home bias. There is a strong link between transparency and information asymmetries. Ahearne et al. (2004) and Pagano et al. (2001) underline the importance of the informational barriers resulting from different national accounting standards and practices. Information costs for outside investors are much higher for companies that lack adequate accounting and governance practices and provide little protection to minority shareholders. La Porta, Lopez-de-Silanes, and Shleifer (1999) find that company ownership is more internationally dispersed in countries with good legal protection of minority shareholders. They also find that firms outside the U.S. are typically controlled by a large resident shareholder, and that the large shareholder is most often a family. Dahlquist et al. (2003) show that differences in corporate governance across countries can help explain the home bias through their impact on share ownership. Most firms in countries with poor investor protection are typically controlled by large domestic shareholders, so that only a fraction of the shares issued by firms in these countries can be freely traded and held by portfolio investors. They estimate that, on average, 32% of the shares listed across 51 countries are not available for trading. In countries where controlling shareholders are economically important, a large home bias in equity holdings can be expected since a large fraction of the outstanding shares is held by resident controlling shareholders. They also show that the economic importance of controlling shareholders outside the U.S. helps explain the home bias of U.S. investors. In the same line, Gelos and Wei (2005) provide strong evidence for a positive relation between both government and corporate transparency and international investments into a particular country; and Giannetti and Simonov (2006) show that the quality of a company’s corporate governance affects not only the stocks held in investors’ portfolios, but also the probability of new investors buying stocks in a company. Inside investors can extract substantial private benefits from companies with poor corporate governance. Foreign investors typically do not enjoy private benefits in domestic firms, and therefore avoid firms with weak corporate governance to minimize expropriation risks.

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Stulz (2005) reasons that home bias can be caused by a twin agency problem. On the one hand, there is the agency problem of corporate-insider discretion, meaning that inside investors can extract private benefits and thereby expropriate outside investors. On the other hand, there is the agency problem of state-ruler discretion, meaning that state rulers can expropriate investors by regulations and taxes that are used for the state rulers’ own benefit. Stulz shows both empirically and theoretically that share ownership is more concentrated in countries where investor protection is poor and/or the risk of state expropriation is high. The twin agency problem affects international portfolio holdings in three ways: (1) countries with poor governance have a smaller fraction of wealth owned by foreign investors because insiders have a larger ownership share in such countries; (2) smaller countries have a larger fraction of wealth owned by foreign investors, and portfolio investors who live in smaller countries with a smaller share of the world market portfolio invest more abroad; and (3) countries with a high risk of state expropriation have a lower fraction of wealth owned by foreign investors, all else being equal. In a similar context, Kho et al. (2009) show that in countries with weak governance and weak institutions, concentrated ownership is optimal. Consequently, for home bias to disappear in countries with weak public governance, the development of institutions that support decentralized ownership is crucial. More specifically, they state that governance has two main effects on the home bias. The first is what may be called the “direct effect” of governance on the home bias: Poorer governance leads to a higher level of insider ownership, which limits portfolio holdings by foreign investors. The second effect is what may be called the “indirect effect” of governance on the home bias: Poorer governance also implies higher ownership by domestic monitoring shareholders and, as the ownership of these investors increases, domestic investors (in aggregate) become more overweight in domestic stocks, further limiting the portfolio investment of foreigners. They use both country-level data on U.S. investors’ foreign investment allocations and Korean firm-level data, and find empirical evidence supporting their argument.

1.6 Behavioral factors All possible explanations for international underdiversification brought forward so far rely on the traditional research methodology that is based on the assumption of perfectly rational behavior of individuals. However, psychologists and experimental economists have found that in an experimental setting, people tend to suffer from behavioral biases. Since the development of the prospect theory by Kahneman and Tversky (1979) and Tversky and Kahneman (1992), behavioral finance has emerged as an established research area (see Barberis and Thaler 2003 for a survey). To explain the home bias in equity portfolios, researchers have developed behavioral models. Although there are intuitive explanations for the observed home bias, a major question is what equilibrium asset pricing would be consistent with such explanations. International CAPMs have been developed to model some

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common forms of barriers to international investment. These international CAPMs assume partial or full international market segmentation (Chaieb and Errunza 2007; Errunza and Losq 1985; Stulz 1981a, 1981b), and they imply, by construction, home bias. Actually, numerous authors have questioned whether non-behavioral explanations could justify the extent of the observed home bias. French and Poterba (1991) suggest that explanations for the home bias puzzle must be behavioral, not institutional. For example, globalization has removed many barriers to international investments, at least in developed markets. Information is now widely and rapidly disseminated, at least for large firms that make up the bulk of world market capitalization. Currency risk can be easily hedged. Some recent papers have put forward a behavioral explanation for the equity home bias. Using departures from rational expectations and maximization of standard von Neumann–Morgenstern utility functions used in the traditional literature, this new literature has highlighted some behavioral biases consistent with the data on international portfolio allocation. 1.6.1 Familiarity Huberman (2001) notes that domestic investors consider foreign markets as more risky than they truly are, simply because they are foreign. Investors are more familiar with domestic stocks and feel a general sense of discomfort or even fear towards foreign assets. Huberman (2001) offers a novel explanation of the home country bias: people simply prefer to invest in the familiar. People root for the home team, and feel comfortable investing their money in a business that is visible to them. Paucity of international diversification is only one of the implications of this tendency to invest in the familiar. Huberman (2001) notes that shareholders of an RBOC tend to live in the area which it serves, and an RBOC’s customers tend to hold its shares rather than other RBOCs’ equity. In every state but Montana, more people hold shares of the local RBOC than of any other single RBOC. In most states, more money is invested, per investor, in the local RBOC than in any other RBOC. A typical investor in an RBOC tends to invest more money if he/she invests in the local RBOC than if he/she invests in an out-of-state RBOC. Typical account size ranges between $10,000 and $20,000, a considerable amount to be invested in a single stock in comparison with the typical U.S. household’s net worth as well as direct and indirect stock holdings. The usual explanations for the small scale of international stock diversification are irrelevant here, as each of the seven RBOCs is equally accessible to the U.S. investing public, their shares trade on the New York Stock Exchange, and their market capitalizations are large. The geographic bias of the RBOC investors is closely related to: (1) the general tendency of households’ portfolios to be concentrated; (2) the employees’ tendency to own their employers’ stocks in their retirement accounts; (3) the geographic bias of U.S. domestic fund managers for local stocks; and (4) the home country bias in

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the international arena. Together, Huberman (2001) concludes, these phenomena provide compelling evidence that people invest in the familiar while often ignoring the principles of portfolio theory. Furthermore, the evidence suggests that in addition to perceived risk and return, other variables – familiarity, for instance – affect investment choices, or that these other variables affect the perception of risk and return. Ackert et al. (2005) and Karlsson and Norden (2007) have contributed to this literature. Huberman (2001) notes that investment in the familiar manifests itself in more than just the home country bias. Coval and Moskowitz (1999) find that U.S. investment managers exhibit a strong preference for locally headquartered firms in their domestic portfolios (Chan et al. 2005; Li, 2004). Feldstein and Horioka (1980) document high positive correlation between a country’s savings and its investment rate, arguing that capital flows to familiar (domestic) investment opportunities, not necessarily to the most profitable. Kilka and Weber (2000) show that German business students are more optimistic about German stocks than American stocks, and vice versa for American business students. More than 30% of defined contribution pension money is invested in the employer’s stock. And respondents to a Gallup survey (Driscoll et al. 1995) view their own employer’s stock as safer than a diversified stock fund, whether domestic or international. Merton (1987) offers an asset pricing theory that deviates from the CAPM because investors focus on the familiar. In that work, every stock is familiar to a subset of investors in the sense that they – and only they – know the parameters of the stock return’s distribution. Investors trade only in securities with which they are familiar; otherwise they are rational mean-variance maximizers. In equilibrium, stocks with a smaller investor base will have lower prices and higher expected returns. Coval and Moskowitz (1999) report that the typical equity portfolio of a U.S. money manager consists of stocks of firms that are located 100 miles closer to the manager’s office than the average U.S. firm (Ivkovic and Weisbenner 2005). Coval and Moskowitz (1997) find abnormal performance in locally held firms, and interpret their results as evidence that information advantages motivate investors to favor nearby investments. Investment in the familiar extends to workers who choose to invest some, or perhaps all, of their retirement money in their employer’s stock. In some cases, workers prefer to buy the company stock instead of investing in the other options available in their pension plans. In other cases, the preference for the company stock is induced by a matching contribution from the employer. And in still other cases, it is the company that contributes its own stock to the plan, without offering the workers any choice in the matter. Benartzi (2001) notes that roughly a third of assets in large retirement savings plans are in company stock. Employees invest 20% to 30% of their discretionary funds in company stock, as opposed to being required to own company stock. Liang and Weisbenner (2002), Meulbrook (2005), and Mitchell and Utkus (2003) have also contributed to this literature.

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Employers may, and some do, offer incentives to workers to include the company stock in their retirement accounts. In these cases, stockholders essentially sell the firm’s shares to workers at a discount. A standard application of the principal-agent theory cannot account for this behavior, since in a large firm, most individuals’ job performance hardly affects the bottom line. It seems that employers have two mutually enhancing reasons for seeing rank-and-file workers as fellow shareholders: (1) this makes employees identify more strongly with the company and thereby motivates them to become better workers; and (2) workers actually like to hold the company stock – it is familiar. Even in the absence of an explicit financial inducement, many employees choose to hold their firm’s stock in their 40l(k) accounts. For instance, the presumably financially sophisticated employees of J.P. Morgan invest 19% of their 40l(k) plan money in J.P. Morgan’s stock, although the firm offers no incentive to make this particular choice ( J.P. Morgan 1997). In some companies, even when employees have the choice of other investment options, they tend to go for what they know. Employees of Abbott Labs, until January 1996, had no choice: All of the 401(k) money went into company stock. Then the company added four investment choices and the chance to reallocate. Today, according to Business Week (1997), 68% of the employees’ regular investment still goes toward stock and the total plan remains 90% invested in Abbott shares. Krane (1996) provides an example of how badly workers of one company were hurt, having invested their retirement money with the company’s stock. Employees of Color Tile still do not know how much money they lost. Most of their 40l(k) is invested in company stock and real estate, but the company, a retailer of home-decorating materials based in Fort Worth, declared bankruptcy in January. That froze the estimated $20 million in the plan and its exact value is unknown. According to Schultz (1996a), Color Tile’s 401(k) plan had 1,362 participants. Kahn (1997) reports on the 401(k) plan of Mercury Finance, a firm whose stock price dropped from $12.25 on December 31, 1996, to $2.25 on April 4, 1997. According to Kahn, of a total of about 1,900 workers, nearly 900 are enrolled in the company’s 401(k) plan. And according to the plan data for 1994, nearly two-thirds of the plan’s assets were invested in Mercury Finance’s own plummeting stock. Besides Mercury stock, workers were offered just one other equity option, a diversified growth fund. The only other active options were a money market fund and a guaranteed investment contract. At the end of 1994, besides the 65.5% in Mercury stock, the plan assets were divided as follows: 18% in the guaranteed investment contract, 8.5% in the equity fund, and 5.5% in the money market fund. Plan participants themselves chose how to divide their contributions to the plan. The John Hancock–Gallup survey compiles the responses of 803 randomly selected individuals whose employers were offering a 401(k), savings, thrift, or profit-sharing plan with a choice of funds in which to invest. To qualify for the survey, these workers had to be currently contributing to the considered retirement plan. The survey’s most relevant finding for this work is that

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participants consider the employer’s stock to be safer than a domestic stock fund, which they consider safer than an international stock fund. In addition, they say that they are more likely to contribute to a familiar investment option, and that their own company stock is the most familiar investment option to them. Driscoll et al. (1995) have also contributed to this literature. Both the data on 401(k) asset allocation and the John Hancock survey suggest that workers’ financial well-being is often closely tied to their employer’s stock. Workers actually like this situation because the employer’s stock is a very familiar investment. Households have a pronounced preference for local stocks. If individual investors’ local investments stem primarily from noninformation-based reasons – as the evidence presented by Grinblatt and Keloharju (2001), Huberman (2001), and Massa and Simonov (2006) – Zhu (2002) suggests, then investors’ locality should be interpreted primarily as a behavioral phenomenon. If locality stems from households investing in the companies they are familiar with, though not necessarily particularly informed about, local investments likely will not earn superior returns on average. Indeed, Benartzi (2001) finds, in the context of 401(k) plans, that allocations to company stock, the most local of all investments, do not predict future company stock returns. Furthermore, Zhu (2002) explores the local bias of individual investors and finds that local bias is driven by simple familiarity, a conclusion different from Ivkovic and Weisbenner (2005) using the same data set. Grinblatt and Keloharju (2001) note that familiarity has many facets. The firm’s language, culture, and distance from the investor are three important familiarity attributes that might explain an investor’s preference for certain firms. The authors find that all three of these attributes contribute to investor preferences for certain stocks. As noted above, using Finnish data, the authors document that investors are more likely to hold, buy, and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor’s native tongue, and that have chief executives of the same cultural background. The influence of distance, language, and culture is less prominent among the most investment-savvy institutions than among both households and less savvy institutions. The authors also show that the preferences tied to these attributes are inversely related to investor sophistication. 1.6.2 Regret Solnik (2008) uses regret theory to explain international underdiversification. Solnik (2008) builds a model where foreign assets are treated as a separate asset class from domestic assets, and the utility function includes a term for fear of the regret suffered when foreign assets underperform domestic assets. Investors use the domestic portfolio as benchmark portfolio and feel the pain of regret when their foreign investments underperform. Solnik’s (2008) model generates a home bias.

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Solnik and Zuo (2012) develop a global equilibrium asset pricing model assuming that investors suffer from foreign aversion, a preference for home assets based on familiarity. Using a utility formulation inspired by regret theory, the authors derive closed-form solutions. When the degree of foreign aversion is high in a given country, investors place a high valuation on domestic equity, which results in a low expected return. Thus, the model generates the simple prediction that a country’s degree of home bias and the expected return of its domestic assets should be inversely related. Their predicted relation between the degree of home bias and a country’s expected return has the opposite sign predicted by models that assume some form of market segmentation. Using International Monetary Fund portfolio data, the authors find that expected returns are negatively related to home bias. 1.6.3 Confidence Home bias should not only occur when domestic investors have an actual information advantage relative to foreign investors; even the perception of an information advantage relative to foreigners can be sufficient to induce home bias. Indeed, if all investors are provided with the same information, it cannot be assumed that any particular group of investors has an actual information advantage. But an overconfident investor has a perceived information advantage concerning the investments that he/she is familiar with. Overconfident individuals are known to misjudge their ability in forecasting the performance of their familiar assets, and overinvest in the assets they are familiar with. Barber and Odean (2001, 2002), and Karlsson and Norden (2007) have also contributed to this literature. 1.6.4 Competence The influence of perceived competence on international investing is evidenced by Graham, Harvey, and Huang (2009) and Kilka and Weber (2000): Investors believe that they are more competent in investing domestically than abroad and therefore treat foreign assets differently for fear of showing incompetence. Huberman (2001) recalls Heath and Tversky (1991), who lay out behavioral foundations for betting on the familiar, but do not explain why the nature of the bet is frequently “buy and hold.” They conduct a series of experiments showing that holding judged probability constant – people prefer to bet in a context where they consider themselves knowledgeable or competent than in a context where they feel ignorant or uninformed. Heath and Tversky (1991) conclude that the competence hypothesis might also help explain why investors are sometimes willing to forego the advantage of diversification and concentrate on a small number of companies with which they are presumably familiar. Kilka and Weber (2000) show in an experimental setting that German investors feel more competent in judging domestic stocks than in judging U.S. stocks. This perceived competence, in turn, seems to have a major influence on

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people’s expectations as expressed by the corresponding subjective probability distributions. In particular, Kilka and Weber (2000) find that subjective probability distributions of stock returns are, on average, more dispersed for stocks about which the investor experiences low competence levels (i.e., foreign stocks) than for stocks associated with high competence levels (i.e., domestic stocks). More specifically, Kilka and Weber (2000) examine the relation between the home country bias and the competence hypothesis by directly eliciting expectations about returns of American and German stocks from American and German business students. The elicited returns expectations were both about individual stocks and about two leading stock indices – the Dow Jones and the DAX. Subjects were asked to assess their competence to form beliefs about the equities in question, and then to provide a rough probability distribution of the returns of these equities. U.S. subjects felt that they were more competent to construct return distributions of U.S. stocks and the Dow than of German stocks and the DAX, and vice versa for the German subjects. For individual stocks, the elicited returns distributions were more dispersed the less competent a subject felt about his/her ability to form such a distribution. In particular, German (U.S.) subjects had higher dispersions for the returns of U.S. (German) than for German (U.S.) equities, and within each country, higher dispersions for the returns of equities about which they felt less competent to judge. This observation seems consistent with Heath and Tversky’s (1991) competence hypothesis. Graham et al. (2009) argue that “investor competence” explains the home bias. In a world where investors make decisions based on their subjective probabilities, psychological factors such as perceived competence can play an important role in explaining investor behavior. The competence effect posits that people’s willingness to act on their own judgments is affected by their subjective competence (Heath and Tversky 1991). When people feel skillful or knowledgeable in an area, they are more willing to bet on their own judgments, and vice versa. Fox and Tversky (1995) and Fox and Weber (2002) provide further evidence that self-perceived competence plays a role in the willingness to act on one’s own judgment (see Camerer and Weber 1992 for a review). The competence effect is particularly relevant to investor behavior. In financial markets, investors are constantly required to make decisions based on subjective probabilities. Investors who feel more knowledgeable in making financial decisions should be more willing to act on their judgments (Heath and Tversky 1991). When an investor feels competent about understanding the benefits and risks involved in investing in foreign assets, he/she is more willing to invest in foreign securities. In contrast, when an investor feels less competent, he/she is more likely to avoid foreign assets. Consistent with these predictions, Graham et al.’s (2009) results suggest that investors with more competence are more likely to invest in international assets. They document that competence has a large economic effect. Using survey data, they measure perceived competence and show that it is an economically important variable that helps explain the home bias puzzle. Home

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bias seems lesser amongst investors who believe they are more skillful or knowledgeable. More specifically, a one standard deviation increase in competence increases by nearly one-third the probability that an investor will invest in foreign assets. 1.6.5 Optimism The seminal paper of French and Poterba (1991) considers optimism toward local assets as a potential explanation for home bias: If investors systematically have higher expectations of relative returns for domestic equities, this difference in expected returns, while imagined, can overturn any perceived diversification gains. French and Poterba (1991) use a simple model of investor preferences and behavior to show that current portfolio patterns imply that investors in each nation expect returns in their domestic equity market to be several hundred basis points higher than returns in other markets. More specifically, French and Poterba (1991) calculate the set of expected returns required to explain existing patterns of international equity holdings of U.S., Japanese, and British investors, given estimates of the return covariance matrix. Their results show, for example for U.S. equities, that U.S. investors must expect annual returns that are 240 and 110 basis points higher than those expected by Japanese and British investors. They conclude that the lack of international diversification appears to be the result of investor choices, rather than institutional constraints. More specifically, French and Poterba (1991) estimate that U.S., Japan, and U.K. investors hold 93%, 98%, and 82% of their equity investments, respectively, in their home countries, and argue that these numbers are inconsistent with standard models of asset allocation. Observing that they can reliably estimate a variance–covariance matrix of returns but not the vector of their expected returns, they consider hypothetical mean-variance optimizing investors and address the following question: Given the variance–covariance matrix and an international asset allocation equal to the aggregate allocation of investors in the particular country, what is the implied vector of expected returns? They compute the expected returns vectors from the perspective of U.S., Japanese, and U.K. investors and compare the imputed expected returns across investors, and for each investor, across countries. Each investor is most optimistic about his/her own country’s equity returns. The expected return on U.S. equities is 5.5% in the eyes of U.S. investors, compared with 3.1% and 4.4% in the eyes of Japanese and U.K. investors, respectively. The expected return on Japanese equities is 6.6% in the eyes of Japanese investors, compared with 3.2% and 3.8% in the eyes of U.S. and U.K. investors, respectively. Of interest, the most egregious numbers come from the investors who display the weakest home bias, the U.K. investors. In their eyes, the expected return on their equities is 9.6%, compared with 4.5% and 3.8% in the eyes of U.S. and Japanese investors, respectively. In the same vein, Shiller, Kon-ya, and Tsutsui (1996) provide survey evidence that domestic investors typically expect domestic stocks to earn more than foreign investors do. Shiller, Kon-Ya, and Tsutsui (1991) document large differences in expected returns of Japanese and U.S. investors for the same stock markets. They

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find that Japanese investors tend to expect relatively higher returns for Japanese stocks, while U.S. investors expect higher returns on U.S. equity. A similar argument can be applied to estimated variances (either the standard deviation of domestic equity is systematically believed to be lower, or correlations with foreign equities are overestimated). More specifically, Shiller et al. (1996) report quarterly forecasts of U.S. and Japanese investors for one-year returns on the Nikkei 225 and Dow Jones Industrial Average between 1989 and 1992. They find investors in each country are more optimistic about their home stock market. A similar form of optimism bias is referred to as wishful-thinking bias in the cognitive psychology literature. Babad (1987) reports that soccer fans engage in wishful thinking about their favorite teams. Babad (1995), and references therein, report a perseverance of wishful-thinking bias in various sporting and voting contexts. Kilka and Weber (2000) show that domestic stocks on average are judged more optimistically than foreign stocks. The authors conducted an experimental study using graduate investment students in Germany and the United States. They find that both test groups feel more competent about domestic stocks, which translates into less dispersion and greater optimism for the distribution of domestic stock returns. Dorn and Huberman (2005), in contrast, find no convincing evidence for over-optimism as an explanation for diversification decisions. Based on questionnaire data from Germany from January 1995 to May 2000, they show that both diversification and turnover are driven mainly by the investor’s risk attitude: portfolios of risk-averse investors contain twice as many positions as those of risk-tolerant investors. Strong and Xu (2003) use survey data of fund managers’ views on prospects for international equity markets. The authors analyze monthly surveys of fund-manager sentiment for four major geographical domains (U.S., U.K., continental Europe, and Japan) covering the 61-month period from October 1995 to October 2000. Their results confirm the findings of French and Poterba (1991), Kilka and Weber (2000), and Shiller et al. (1996) in showing that fund managers show a significant relative optimism towards their domestic markets, including their home equity market. A favorable view of stocks with which a person has an affinity, whether he/ she has a stake in them or not, recalls wishful thinking. Indeed, it has been documented that people who vote for a party assign that party a higher probability of winning the election than those who do not vote for it. And fans of a sports team who bet on the outcomes of ballgames are more likely than those who do not support that team to bet that their favorite team will win. Babad and Yosi (1991), Babad (1995), and Bar-Hillel and Budescu (1995) have contributed to this literature. 1.6.6 Culture The relative level of investment in overseas markets can be related to cultural similarities with an investor’s home market. Beugelsdijk and Frijns (2010), Dopfel (2008), and Kim (2017) have also contributed to this literature.

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Extant research has documented a substantial impact of culture and patriotism on equity home bias. Culture is defined by Hofstede (2001) as “the collective programming of the mind that distinguishes members of one group or category of people from another” (Hofstede 2001, p. 9). Hofstede (2001) identifies four cultural dimensions (power distance, masculinity, individualism, and uncertainty avoidance) that are derived based on a survey of IBM employees conducted during the 1967–1973 period. Hofstede, Hofstede, and Minkov (2010) add further cultural dimensions: long-term-orientation and indulgence that are derived based on the 1995–2004 and 2005–2008 World Values Survey data. The GLOBE study of House et al. (2004) distinguishes nine cultural dimensions (uncertainty avoidance, power distance, gender egalitarianism, in-group collectivism, institutional collectivism, assertiveness, humane orientation, performance orientation, and future orientation) that are derived based on a broader industrial setting (financial services, food processing, and telecommunications). Contrary to the research design of Hofstede et al. (2010), the GLOBE study targets only managerial employees, and collects the self-report questionnaires during the time interval between 1994 and 1997. House et al. (2004) differentiate between cultural practices and cultural values: Cultural values are supposed to reflect ideology and the values that should prevail in a society, whereas cultural practices are assumed to describe the actual state of the world, namely the values that currently prevail in the society according to the perception of survey participants. Hofstede (2006) questions the respondents’ ability to correctly assess the values that currently determine their societies. In the world of behavioral finance, culture (e.g., cultural distance, individualism, and uncertainty avoidance) is assumed to influence preferences and behaviors of individual investors and, thus, is an important determinant of the financial decision making. Cultural differences between countries imply a lower degree of familiarity. Uncertainty avoidance is associated with the intolerance of ambiguity. Individualism is related to overconfidence. Anderson et al. (2011), Beugelsdijk and Frijns (2010), and Morse and Shive (2011) confirm that culture impacts home bias in equities. Moreover, the intolerance of ambiguity, overconfidence, and familiarity (i.e., the behavioral underpinnings of the examined cultural variables) are not assetspecific (i.e., both stocks and bonds) behavioral determinants, and culture is shown to affect the portfolio investment decisions of not only individuals, but also institutional investors. Anderson et al. (2011) and Beugelsdijk and Frijns (2010) have also contributed to this literature. The economic impact of cultural characteristics has been examined in the context of syndicated loan markets (Giannetti and Yafeh 2012), national preferences for bank-based versus market-based financing (Aggarwal and Goodell 2009; Kwok and Tadesse 2006), life insurance consumption (Chui and Kwok 2008), trading volume and momentum profits (Chui, Titman, and Wei 2010), investor rights protection (Stulz and Williamson 2003), crossborder acquisition performance (Morosini, Shane, and Singh 1998), as well as

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international trade and investment (Guiso, Sapienza, and Zingales 2009). Beugelsdijk and Frijns (2010) examine the impact of uncertainty avoidance, individualism, and cultural distance on the foreign bias in the mutual fund equity holdings of developed countries in 1999 and 2000. They differentiate between developed and emerging host countries, and find that uncertainty avoidance exerts a stronger impact on investment in equities issued in emerging markets, whereas cultural distance between host and home countries is significant only for investment in equities issued in developed countries. Individualism significantly increases international diversification in both developed and emerging host markets. Anderson et al. (2011) extend the set of cultural variables of Beugelsdijk and Frijns (2010) in order to account for the influence of long-term orientation and masculinity on domestic and foreign bias in the equity holdings of institutional investors as of 2006. They show that cultural distance and uncertainty avoidance increase the domestic bias levels, whereas masculinity and long-term orientation reduce the overinvestment in domestic equities and increase international diversification. With respect to foreign bias and cultural distance, their results confirm the major findings of Beugelsdijk and Frijns (2010): Investment funds are more likely to underweight equities of those host countries that are more culturally distant from the home country. The impact of individualism on domestic bias is positive, but not robust across different specifications. As far as the relationship between individualism and the foreign bias is concerned, the results are not compatible with the evidence of Beugelsdijk and Frijns (2010). According to Beugelsdijk and Frijns (2010), more individualistic societies are less likely to underweight foreign equities in their portfolios. By contrast, Anderson et al. (2011) show that individualism increases underinvestment in foreign equities. Aggarwal, Kearney, and Lucey (2012) investigate the impact of individualism, masculinity, power distance, and uncertainty avoidance on cross-country bond and equity foreign portfolio investment positions. They show that cultural proximity and the three cultural dimensions of Hofstede (2001) – individualism, masculinity, and power distance of both host and home countries – have a positive and significant impact on cross-country bond and equity foreign portfolio investment. Individualism, masculinity, and power distance of host countries increase cross-border debt and equity holdings by similar amounts. By contrast, home country-specific cultural characteristics exert different impacts on crossborder debt and equity holdings: Whereas individualism of the home country has a stronger impact on cross-border equity investment, the impact of masculinity is more pronounced for the cross-border debt investment. Uncertainty avoidance of either home or host country does not significantly influence cross-border debt and equity holdings. One potential drawback of the study by Aggarwal et al. (2012) is that the cross-border debt and equity holdings are absolute values measured in million USD. Absolute values allow no conclusions about the actual weights of cross-country holdings in the debt and equity portfolios of the investing countries. Moreover, Aggarwal et al. (2012) do not account for the fact that host countries with higher market capitalizations of their debt and equity

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markets attract more foreign investment. Thus, their results on cross-border debt portfolio holdings cannot be a priori extended to home bias that measures the deviation of the actual portfolio weight from the optimal portfolio weight, that is, the under- and overinvestment in domestic and foreign debt securities. In the context of syndicated loan markets, Giannetti and Yafeh (2012) identify two channels through which cultural distance may influence individual portfolio decisions: information asymmetries and transaction costs. First, they argue that cultural differences exacerbate the intensity of information asymmetries and the resulting agency problems. Hence, cultural distance should enhance the perceived riskiness of foreign bonds. Second, Giannetti and Yafeh (2012) state that cultural distance may also reflect institutional differences related to legal systems and contracting terms that increase the cost of information gathering and, thus, further reduce the attractiveness of foreign investment. Finally, investors perceive host countries that are culturally similar to their home countries as more familiar (Grinblatt and Keloharju 2001; Huberman 2001). A number of control variables for institutional similarities, information asymmetries, and familiarity (such as common language, common border, geographical distance, and common legal origin) are used in order to examine whether cultural distance has an impact that goes beyond institutional proximity, information asymmetries, and familiarity considerations. Pradkhan (2016) examines whether the documented importance of culture and patriotism for the explanation of equity home bias can be extended to home bias in bond markets, and, thus, indirectly explores whether patriotism and cultural characteristics of the home country are asset-invariant home bias drivers that determine allocations to both debt and equity securities. From a variety of cultural dimensions identified by Hofstede et al. (2010) and House et al. (2004), Pradkhan (2016) chooses uncertainty avoidance and individualism for two reasons. First, these cultural dimensions reflect behavioral aspects that are relevant to portfolio allocation decisions. Second, their definition and measurement are consistent across different studies. Overall, Pradkhan (2016) explores whether patriotism, cultural distance, individualism, and uncertainty avoidance contribute to the explanation of the home bias phenomenon in bond markets. Pradkhan’s (2016) empirical analysis confirms that patriotism and uncertainty avoidance of the home country play an important role in the explanation of the home bias in bonds. Patriotism fosters overinvestment in domestic debt securities and increases underinvestment in foreign debt markets. Societies characterized by higher uncertainty avoidance display a lower preference for foreign debt securities. Pradkhan’s (2016) results are robust to various regression specifications. Pradkhan (2016) notes that, in general, contrary to a vast literature on equity home bias, studies on home bias in bonds are rather scarce, and none of them incorporates either cultural aspects or patriotism in the empirical examination of domestic and foreign bond bias levels. Most existing studies on home bias in bonds focus on neoclassical factors such as financial liberalization, real exchange rate risk, investor protection, economic and financial market development, as well as traditional familiarity proxies such as common border, common language, and

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geographical distance (De Moor and Vanpee 2013; Ferreira and Miguel 2011; Fidora et al. 2007; Solnik and Zuo 2017). On the other hand, Pradkhan (2016) examines the impact of uncertainty avoidance, individualism, and cultural distance on home bias in bonds and, thus, contributes to the existing research of Aggarwal et al. (2012), Anderson et al. (2011), and Beugelsdijk and Frijns (2010), who focus on the impact of culture on home bias in equities and absolute values of foreign portfolio investment positions. Furthermore, following the research of Morse and Shive (2011) on patriotism and domestic equity bias, Pradkhan (2016) fills a gap by studying the impact of patriotism on domestic and foreign bias in bond portfolios. Guiso, Sapienza, and Zingales (2009) examine the extent to which cultural biases affect economic exchange. In a world where contract enforcement is imperfect and/or where it is impossible or prohibitively expensive to write all future contingencies into contracts, the degree of mutual trust is an essential component in any economic exchange. The authors consider the relative trust European citizens have for citizens of other countries. They recognize that people with similar cultural backgrounds and similar appearances tend to trust each other more (Bornhorst et al. 2004; McPherson, Smith-Lovin, and Cook 2001). They, first, document that this trust is affected not only by objective characteristics of the country being trusted, but also by cultural aspects such as religion, history of conflicts, and genetic similarities. They then find that lower relative levels of trust toward citizens of a country lead to less trade with that country, less portfolio investment, and less direct investment in that country, even after controlling for the objective characteristics of that country. They conclude that perceptions rooted in culture are important (and generally omitted) determinants of economic exchange. Their finding provides an explanation for the home bias. Patriotism Home bias appears to be correlated with measures of patriotism. As noted, several studies suggest that patriotism may be an important determinant of investor behavior. Several studies confirm that culture and patriotism impact home bias in equities. Morse and Shive (2011) argue that patriotism causes investors to concentrate their stock holdings at home. Using a sample of 53 countries, they find that measures of patriotism are significantly and positively related to home bias measures, even after controlling for capital controls, diversification benefits, information advantages, and familiarity. Morse and Shive (2011), thus, illustrate one specific dimension in which cultural biases can affect economic choices. Morse and Shive (2011) elaborate further channels through which patriotism may impact on consumer and investor choices: Either patriotic loyalty induces investors to believe that domestic financial products are superior to the foreign ones; or investors purchase domestic products in spite of being aware of their sub-optimality inasmuch as they derive additional utility from supporting the domestic economy.

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Benos and Jochec (2013) show that patriotic sentiment can affect stock returns, and that investors may be subconsciously driven towards stocks with patriotic names at times when patriotic sentiment is especially high, for example during wartime. For instance, governments frequently appeal to the patriotic feeling of the citizens to promote the sovereign debt issuances. The “Patriot Bonds” of the U.S. government is one example of a successful patriotic promotion of sovereign bonds (Morse and Shive 2011). Benartzi (2001) and Cohen (2009) document a strong tendency among employees to invest their discretionary benefits into their employer’s stocks. Shimp and Sharma (1987) introduce the concept of consumer ethnocentrism that describes the behavior of a consumer who questions the appropriateness and morality of purchasing foreign products. They argue that, albeit a separate concept, consumer ethnocentrism is closely related to patriotism. Loyalty Cohen (2008) shows that employees’ bias toward investing in their own company is not due to information, but to some form of loyalty toward their company. Cohen’s (2008) paper, thus, illustrates one specific dimension in which cultural biases can affect economic choices. 1.6.7 Investor characteristics Studies that focus on the portfolio compositions of individual investors have concluded that the tendency to overinvest in domestic assets is related to specific investor characteristics. Less sophisticated or less experienced investors are more home-biased than sophisticated investors (Goetzmann and Kumar 2004; Grinblatt and Keloharju 2001; Karlsson and Norden 2007). There is a significantly positive relation between age and diversification and income and diversification (Goetzmann and Kumar, 2004). Karlsson and Norden (2007) find that men have a tendency to be relatively more home-biased than women. A potential explanation for this finding, according to Barber and Odean (2001), is that men are more overconfident than women. 1.6.8 Peer comparisons and habit persistence Peer group risk arises from a concern with one’s outcomes relative to those achieved by others in the same group – “keeping up with the Joneses” – and is a central component of the model proposed by Warren (2010). While the literature has not directly investigated the role of peer comparisons, it has examined a close counterpart in terms of habit persistence models (Lauterbach and Reisman 2004; Shore and White 2006). These models generate home bias by assuming that people care about their consumption relative to their countrymen, and then establishing a clear link between this “consumption habit” and returns from local assets. Gomez, Priestley, and Zapatero (2009) have also contributed to this literature.

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1.6.9 Loss aversion Amonlirdviman and Carvalho (2010) study the effect of loss aversion on home bias. They note that loss-averse decision makers have preferences over gains and losses relative to a reference point, rather than overall wealth. Typically, such preferences display a kink at the reference point, with the slope of the utility function over losses being steeper than the slope of the utility function over gains. For a given absolute loss or gain, this implies a first-order difference between the decrease in utility due to a wealth loss and the increase in utility due to a wealth gain of equal magnitude. When choosing equity portfolios, investors must consider the fact that co-movements in international stock market returns are asymmetric: Correlations are higher in market downturns than in upturns. For any level of unconditional co-movement in international stock returns, a higher asymmetry should dampen the gains from diversification for investors with standard expectedutility preferences. This dampening effect is even stronger for loss-averse investors due to the first-order difference between the utility impact of losses and gains. This leads risk-averse investors to tilt their portfolio towards home equity. 1.6.10 Beliefs Dumas et al. (2017), building on Dumas, Kurshev, and Uppal (2009), develop a standard two-country general equilibrium model (in continuous time) where investors exhibit behavioral biases in the form of differences in their beliefs. Investors have access to the same information set (no asymmetric information), but differ in their beliefs about the information contained in economic public signals: Local investors have higher trust in the information contained in local signals, and incorrectly believe that the information in the foreign signal is partly noise. These asymmetric beliefs help the authors to solve for some anomalies at the international level: Investors exhibit home equity bias; asset prices are a combination of a local CAPM and an international CAPM (in line with the empirical evidence of Bekaert and Harvey 1995); and, as in models of asymmetric information (Brennan et al. 2005), capital flows toward a country co-vary positively with returns in that country. Their model with differences in beliefs is indeed observationally equivalent to existing models of segmented markets due to asymmetric information. Epstein and Miao (2003) characterize the equilibrium of a complete market economy when agents have recursive multiple-priors utility in a set-up that affords the Knightian distinction between risk and ambiguity. Under the assumption that foreign securities are exogenously perceived as more ambiguous than domestic ones, the authors obtain home bias, excessive turnover, and high correlations between country-specific consumption and output growth. 1.6.11 Narrow framing Magi (2009) provides an explanation of home bias in a framework where economic agents have behavioral (narrow framing) preferences. The representative

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agent derives utility not only from consumption (standard models) but also from risky financial wealth fluctuations. Moreover, the investor frames the stock market risk narrowly and has loss-averse preferences. That is, even if stock market risk is just one of many risks that determine their overall wealth risk, the investor still gets utility directly from stock market fluctuations (narrow framing) and is more sensitive to losses than to gains (loss aversion). The author numerically solves for the foreign equity share, a simple model of international portfolio choice, providing a possible explanation for the equity home bias puzzle. 1.6.12 Ambiguity aversion Dimmock et al. (2016) note that households must consider both risk and ambiguity when making investment decisions. Risk refers to events for which the probabilities of the future outcomes are known. Ambiguity refers to events for which the probabilities of the future outcomes are unknown. Most people are ambiguity-averse, that is, they prefer a lottery with known probabilities to a similar lottery with unknown probabilities. Several theoretical papers argue that ambiguity aversion can explain this puzzle, because, relative to the domestic stock market, foreign stocks are relatively ambiguous and own-company stock is relatively unambiguous (Boyle et al. 2012; Cao et al. 2011; Epstein and Miao 2003; Uppal and Wang 2003). Thus, the portfolio of an ambiguity-averse investor is biased away from foreign stocks but toward own-country stock. The authors provide non-laboratory empirical evidence that ambiguity aversion relates to home equity bias puzzles. They find that ambiguity aversion is negatively related to foreign stock ownership, but positively related to own-company stock ownership. Their results also provide evidence that ambiguity aversion is not simply a proxy for risk aversion, because, for foreign and own-company stock ownership, the theoretical effect of risk aversion is exactly opposite to that of ambiguity aversion. A problem with a behavioral-based explanation for home bias is that psychological constructs are difficult to measure and to distinguish. For instance, Grinblatt and Keloharju (2001) find that Finnish investors prefer assets controlled by Finnish-speaking managers. They argue that investors prefer domestic companies because they are more familiar with them. But alternative explanations for their findings are that Finns are simply more patriotic towards Finnish firms, or that domestic investors do have actual information advantages relative to foreigners since they understand the language and local culture better. Unobservable psychological attributes, such as overconfidence, are central to the behavioral approach. They are often proxied by objective investor attributes such as age and gender. However, one can argue whether gender is a good proxy to measure a subjective attribute such as overconfidence. Another way to handle subjective investor attributes is the use of questionnaires or experiments. Two problems can emerge in this case. First, if multiple proxies are proposed to measure the same attribute, it is often the case that individuals’ responses are poorly correlated across proxies. Second, questionnaire- or experiment-based studies are difficult to

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extend to other populations – the proxies used may lose their validity for other populations. Dorn and Huberman (2005) have also contributed to this literature. Nowadays, the most popular explanations for the equity home bias are information asymmetries, governance issues, and behavioral biases, as the other proposed explanations seem to fail empirically in explaining much of the actual portfolio choices of investors. Researchers are still debating whether rational decision making (information asymmetries) or bounded rationality (behavioral finance) are the right track to follow. Ke, Ng, and Wang (2010) try to determine whether the foreign investment decisions of professional money managers are influenced by information asymmetries rather than by investment in the familiar. They find no supporting evidence for the information-based explanation and, therefore, tend to conclude that the preference for physically proximate investments is driven by psychological familiarity issues. In contrast, Massa and Simonov (2006) argue that familiarity-driven investment decisions are a rational response to information constraints and not a behavioral heuristic. DeMarzo, Kaniel, and Kremer (2004), within a rational framework, find that the impact of familiarity depends on the degree to which the investor is informed: Better-informed investors are less affected by familiarity. They conclude that the investment choice is driven by the availability of information, and that familiarity is a substitute for better information.

1.7 Conclusion This chapter reviewed several explanations that have been brought forward for the equity home bias puzzle. This vast literature has not succeeded in providing a generally accepted explanation for the home bias. The consensus is that no single explanation offers a complete solution to the home bias puzzle, but each explanation discussed in this literature review is valuable. Portfolio decisions of investors are probably driven by a mixture of all explanations discussed in the literature. This implies that home bias is complex and very hard to model theoretically, and portfolio allocation decisions are likely to keep intriguing and inspiring researchers in the future.

Note 1 Previous surveys of this literature, from which this paper has benefitted enormously, include Coeurdacier and Rey (2013), Cooper, Sercu, and Vanpee (2013), Karolyi and Stulz (2003), Lewis (1999), and Sercu and Vanpee (2007).

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2

Place attachment

This chapter discusses the concept of place attachment – the bonding that occurs between individuals and their meaningful environments. Place attachment has been examined in many fields of study, and therefore, it has been conceptually defined in various ways and has been methodologically approached in different ways. Some people regard the situation as chaos, and therefore, some organizing frameworks would be helpful. In this chapter, Section 2.1 discusses a tripartite framework for organizing definitions, and Section 2.2 provides a multi-paradigmatic framework for organizing methodologies.

2.1 Definitions: A tripartite organizing framework Place attachment has gained much scientific attention in recent years. Part of this interest stems from the awareness that person–place bonds have become fragile as globalization, increased mobility, and encroaching environmental problems threaten the existence of, and our connections to, places important to us. Place attachment is also relevant to the study of environmental perception. Attached individuals experience a heightened sense of safety, even when their place is situated in a war zone. On a smaller scale, attachment to one’s neighborhood is associated with fewer perceived incivilities (e.g., drug dealing, gang activity, traffic) on one’s block and less fear of neighborhood crime. Place attachment has been researched quite broadly, and so has been defined in a variety of ways. The various definitions of the concept can be synthesized into a three-dimensional person–process–place organizing framework. The person dimension of place attachment refers to the meanings that are associated with the place by an individual or a collectivity of individuals. The psychological process dimension includes the affective, cognitive, and behavioral components of attachment. The place dimension emphasizes the place characteristics of attachment, including spatial level, specificity, and the prominence of social or physical elements. The framework organizes related place attachment concepts and thus clarifies the term.1 Because of the application of place attachment to many perspectives, a plenitude of definitions has accumulated. For the most part, researchers portray place attachment as a multifaceted concept that characterizes the bonding between

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individuals and their important places. However, variations in this definition are vast. Humanistic geographers argue that a bond with a meaningful space, or “sense of place,” is a universal affective tie that fulfills fundamental human needs. Some authors suggest that sense of place encompasses the sub-concepts of place identity, place attachment, and place dependence, or that it includes ancestral ties, feeling like an “insider,” and a desire to stay in the place. In the immigration and refugee literature, however, the emphasis is typically on displacement, or “diaspora,” such that attachment is defined by the intensity of longing for places that are lost. Urban sociologists and community scientists locate attachment at the city, home, and neighborhood levels. Even within disciplines, models diverge in their definitions of place attachment; for example, place attachment has been said to rely on social features, physical features, or both. By exploring the commonalities across the different permutations of the concept, it is possible to shape, then structure, a coherent understanding of it. Scannell and Gifford (2010) propose a three-dimensional framework of place attachment that usefully structures the varied definitions in the literature. This framework proposes that place attachment is a multidimensional concept with person, psychological process, and place dimensions, as in Figure 2.1. The first dimension is the actor: Who is attached? To what extent is the attachment based on individually and collectively held meanings? The second dimension is the psychological process: How are affect, cognition, and behavior manifested in the attachment? The third dimension is the object of the attachment, including place characteristics: What is the attachment to, and what is the nature of, this place? This three-dimensional framework of place attachment organizes the main definitions in the literature and, as knowledge grows about the specific levels within each of these dimensions, a comprehensive understanding of place attachment will be reached. 2.1.1 The person dimension: Individual and collective place attachment Place attachment occurs at both the individual and group levels, and although definitions of the term tend to emphasize one over the other, the two may overlap. At the individual level, it involves the personal connections one has to a place. For example, place attachment is stronger for settings that evoke personal memories, and this type of place attachment is thought to contribute to a stable sense of self. Similarly, places become meaningful from personally important experiences, such as realizations, milestones (e.g., where I first met my significant other), and experiences of personal growth. At the group level, attachment is comprised of the symbolic meanings of a place that are shared among members. Group-framed place attachment has been examined in different cultures, genders, and religions. For example, attachment has been described as a community process in which groups become attached to areas wherein they may practice, and thus preserve, their culture. Culture links members to place through shared historical experiences, values, and symbols. In a study of landscape perception, forests were perceived

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Place attachment The three-dimensional, person-process-place, organizing framework relates place attachment concepts and thus clarifies the term.

Cultural/Group

• •

Religious Historical

Individual

• • •

Experience Realizations Milestones

Affect

• • •

Happiness Pride Love

Cognition

• • • •

Memory Knowledge Schemas Meaning

Behavior

• •

Proximity-maintenance Reconstruction of place

Social

• •

Social arena Social symbol

Physical

•

Natural built

Person

Place Attachment

Process

Place

Figure 2.1 The tripartite model of place attachment

to be more threatening for Hispanic Americans, African Americans, and women; and less threatening for European Americans and men. It can be speculated that different meanings arise from historical events, religions, and other experiences common to group members, and that these meanings are transmitted to subsequent generations. In addition, place attachment may be religiously based. Through religion, the meanings of certain places become elevated to the status of sacred. Revered places – such as Mecca or Jerusalem or, on a smaller scale, churches, temples, shrines, burial sites, or divine places in nature – are central to many religions, and their sacred meanings are shared among worshippers. Not only do such places seem to bring worshippers closer to their gods, but reverence for, and protection of, these places essentially reflects one’s cultural fealty. Although religions often designate which places are important, religious connections to place can also be individual – a place may gain spiritual significance through personal experiences (e.g., an epiphany).

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Therefore, the cultural and individual levels of place attachment are not entirely independent. Cultural place meanings and values influence the extent of individual place attachment, and individual experiences within a place, if positive, can maintain and possibly strengthen cultural place attachment. 2.1.2 The psychological process dimension of place attachment The second dimension of place attachment concerns the way that individuals and groups relate to a place, and the nature of the psychological interactions that occur in the environments that are important to them. The three psychological aspects of place attachment (or, according to some authors, sense of place), typically highlighted in its various theoretical and operational definitions, are affect, cognition, and behavior. Some definitions include all three of these components, others emphasize only one or two of them. This organization of place attachment is common to other social psychological concepts such as attitudes and prejudice, which are also characterized by affective, cognitive, and behavioral components. Place attachment as affect Person–place bonding undoubtedly involves an emotional connection to a particular place. Humanistic geographers describe place belongingness in emotional terms. For example, some use topophilia or love of place for this connection, and some others define place attachment as the authentic and emotional bond with an environment that satisfies a fundamental human need. Environmental psychologists similarly assert the central role of affect in person–place bonding. Most often, their definitions portray place attachment in affective terms, such as an emotional investment in a place, or feelings of pride and a general sense of well-being. Some evidence that attachment to a place is grounded in emotion comes from the literature on displacement, when individuals must leave their places, such as in the event of a natural disaster or war, immigration, or relocation. Relationships with place can represent an array of emotions, from love and contentment to fear, hatred, and ambivalence. For example, one can experience a childhood home as a significant place, but that does not necessarily mean the bond is positive. Rather, unhappy or traumatic experiences in a place may create negative feelings or even aversion toward it. Although strong negatively valenced bonds can form with important places, attachment usually is defined in positive terms; the desire to maintain closeness to a place is an attempt to experience the positive emotions that a place may evoke. Place attachment as cognition Person–place bonds also include cognitive elements. The memories, beliefs, meaning, and knowledge that individuals associate with their central settings

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make them personally important. Place attachment as cognition involves the construction of, and bonding to, place meaning, as well as the cognitions that facilitate closeness to a place. Through memory, people create place meaning and connect it to the self. As noted earlier, one can grow attached to the settings where memorable eras or important events occurred. These can be described as symbolic communities, because the attachment is based on the representations of the past that the setting contains. Individuals structure social information so that it is maximally coherent and easy to process. This information is organized into sets of cognitions, or schemas, which include knowledge and beliefs about particular objects, or the self. Schemas may be applied to place attachment. For example, familiarity may be viewed as the cognitive component of place attachment; to be attached is to know and organize the details of the environment. The notion of settlement identity, or generic place dependence, suggests that individuals are attached to certain types or categories of places (e.g., cottages in rural settings, suburban single-family dwellings, or downtowns). For these attachments, the schema contains information about the features common to the types of place to which one may become attached. A favorite place may be a kind of place schema of place-related knowledge and beliefs, which ultimately represents the special character of the place and one’s personal connections to it. In turn, these cognitions can become incorporated into one’s self-concept. The term place identity has been used to describe the physical world socialization of the self, or the self-definitions that are derived from places. This occurs when individuals draw similarities between self and place, and incorporate cognitions about the physical environment (memories, thoughts, values, preferences, categorizations) into their self-definitions. Salient features of a place that make it unique (e.g., architecture, historical monuments, a cultural community) can be attached to one’s self-concept, a process that may be called place-related distinctiveness. This process is comparable to the development of social identity as described by optimal distinctiveness theory, which asserts that social identity forms when a person seeks a balance of similarity to in-group members, and distinctiveness from out-groups. Place also provides information about one’s distinctiveness or similarity, information that may be based on physical or social features. Similarity would represent a sense of belonging to a place, and could be attained in a neighborhood, for example, from comparisons of the physical appearance of one’s house to the houses of proximal others. Differentiation in place identity would depend on distinguishing features such as climate or landscape and their relevant connotations (e.g., “we are island people”). In general, individuals may connect to a place in the sense that it comes to represent who they are. Connections to place may be cognitive, and can sometimes be incorporated, at the most personal level, into one’s self-definition.

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Place attachment as behavior The third aspect of the psychological process dimension of place attachment is the behavioral level, in which attachment is expressed through actions. Like interpersonal attachment, place attachment is typified by proximity-maintaining behaviors and is a positive, affective bond between an individual and a specific place, the main characteristic of which is to maintain closeness to such a place. The idea of place attachment as proximity-maintaining behavior is supported in studies that relate place attachment to length of residence and efforts to return. The literature on homesickness shows that some individuals who have been absent from their home for an extended period of time express a great desire to return to or visit the place, and at times the return can involve much effort or cost. A religious pilgrimage is another behavior that exemplifies efforts made to be close to one’s significant place. Nevertheless, maintaining proximity to one’s place is not constantly enacted by the securely attached individual; one may be highly attached to a place, and yet depart from it regularly. In fact, place attachment can even become dysfunctional when an individual with a rigid bond to home is reluctant to leave it. For example, these individuals may miss important opportunities, or even put themselves in mortal danger for the sake of remaining in the place. Furthermore, the dialectical process of being at home versus being away from home aids in the development of place meaning. Through journeys away, in combination with proximity-maintaining, individuals are better able to understand and appreciate routine aspects of their place. Together, these behaviors contribute to the construction and expression of the person–place bond. Another interesting behavioral expression of place attachment is the reconstruction of place, as has been observed in post-disaster cities. It has been documented in the literature regarding the rebuilding of Xenia, Ohio, a town that was devastated by a tornado in 1974. The destruction gave planners the opportunity to rectify planning problems that had existed prior to the disaster, such as the decline of downtown and increased suburbanization. Nevertheless, local residents and businesses used their power to override the post-disaster zoning maps that had been proposed, and ultimately, the new Xenia looked much like it had before the disaster. Recreating a familiar town proved more important than addressing planning flaws. This shows the role of place meaning, nostalgia, and the desire to restore meaningful areas to which residents were attached. Similar acts of reconstruction have been observed, such as those following the 1976 earthquake in Friuli, Italy, and the 1964 earthquake in Anchorage, Alaska. Familiarity and use took precedence over planners’ wishes; residents manifested their attachments by recreating the city to which they were bonded, even if it was flawed. Another form of place reconstruction occurs when individuals must relocate to a new place. Some choose to preserve the bond by selecting locations that are as similar as possible to the old place. This was observed among Boston West Enders who, when forced to relocate, selected areas of Boston reminiscent of their previous neighborhood.

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Place attachment behaviors are not necessarily territorial, although the two may overlap, given that place use is an element of both. Territoriality is based on ownership, control of space, and the regulation of access to self, but attachment to places is an affective, proximity-maintaining bond that can be expressed without an underlying purpose of control, especially for public spaces such as parks or cafés, or sacred spaces. Further, territorial behaviors include marking, personalization, aggression, and territorial defense, whereas place attachment behaviors include pilgrimages, social support, and place restoration. The behavioral level of place attachment, therefore, is founded on the desire to remain close to a place, and can be expressed in part by proximity-maintaining in concert with journeys away, place reconstruction, and relocation to similar places. 2.1.3 The place dimension Perhaps the most important dimension of place attachment is the place itself. What is it about the place to which we connect? This dimension has been examined at various geographic scales (e.g., a room in a house, a city, or the world), and has typically been divided into two levels: social and physical place attachment. In a study that measured the social and physical levels of place attachment at three different spatial levels (home, neighborhood, and city), it was found that the strength of the attachment differed depending on the level of analysis: greater place attachment emerged for the home and city levels than for the neighborhood level, and the social dimension of place attachment was stronger than the physical dimension. Nevertheless, it should be stressed that physical and social attachments both influence the overall bond, and that spatial level should be considered when measuring place attachment. Some suggest that social attachment, or bondedness, consists of social ties, feeling of belonging to the neighborhood, and familiarity with fellow residents and neighborhood children; and that physical attachment, or rootedness, is predicted by length of residence, ownership, and plans to stay. Nevertheless, much of the research on place attachment (and related concepts) has focused on its social aspect – people are attached to places that facilitate social relationships and group identity. One study was conducted in a neighborhood that was quite dilapidated, but demonstrated that the strong neighborhood bonds can stem from interpersonal interactions. In another study, attachment in a London neighborhood was based on the ability to interact frequently with relatives. Certain physical features, such as density, proximity, and the presence of amenities and other social arenas, influence these interactions, but when the attachment is directed toward others who live in the place rather than to aspects of the place itself, it is considered to be a socially based place bond. According to urban sociologists, place attachment is necessarily social, and as such it is sometimes compared to, or conflated with, the sense of community. Community is a complex system of friendship and kinship networks and formal

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and informal associational ties rooted in family life and on-going socialization processes. Two types of community have been distinguished: community of interest, where members are connected through lifestyle and common interests; and community of place, where members are connected through geographic location. Communities of interest are not always place-bound, such as in the case of online, professional, or religious groups that are connected without reference to a place, and so this term is not specific to place attachment. Community of place, however, is more relevant to our framework because it describes social ties rooted in place, such as neighborhoods, coffee shops, or other spaces that support social interaction. Some believe that local sentiments and ties are created by the broader social system of mass society, which dictates status based on class, race, and religion. Individuals of similar status and life-stage select the location and type of dwelling according to their lifestyles and economic constraints. As a result, pockets of relatively homogeneous communities emerge, and within these neighborhoods, interpersonal attachments and networks develop. In a study that investigated whether local community sentiments can persist in mass society (the systemic model) or erode as population size and density increase (the linear model), support was found for the systemic model: Length of residence was associated with greater social ties, including the number of local acquaintances, friends, and relatives. These social bonds, in turn, predicted local community attitudes and sentiments. Similarly, other community attachment researchers assume that attachment to a place means attachment to those who live there and to the social interactions that the place affords them. They note that spatial bonds become important largely because they symbolize social bonds. Thus, part of social place bonding involves attachment to the others with whom individuals interact in their place, and part of it involves attachment to the social group that the place represents. This latter type of attachment, and the recognition that the place symbolizes one’s social group, is closely aligned with place identity; one is attached to the place because it facilitates distinctiveness from other places, or affirms the specialness of one’s group. Civic place attachment is an instance of group-symbolic place attachment that occurs at the city level. Nationalism is another example of attachment to, and identification with, a place representative of one’s group, but on a broader scale. These definitions suggest that social place attachment can sometimes center upon the place as an arena for social interactions, or as a symbol for one’s social group. However, attachment obviously can also rest on the physical features of the place. The definition of place dependence, for instance, highlights the physical characteristics of a place as central to attachment because it provides amenities or resources to support one’s goals. The types of places that individuals find meaningful represent a broad range of physical settings, from built environments such as houses, streets, certain buildings, and nonresidential indoor settings, to natural environments such as lakes, parks, trails, forests, and mountains.

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Most likely, place attachment bonds exist because they serve several functions. Of those speculated upon in the literature, the most common include survival and security, goal support, temporal or personal continuity, belongingness, identity, and self-esteem. Implicit in each of these proposed functions is a particular definition of place attachment. In sum, three dimensions of place attachment are postulated: person, psychological process, and place. Given the complexity of person–place bonding, many threads tie individuals to their important places. Some are stronger or more salient than others, several are twisted together and seem inseparable, and few are apparent to outside observers. The tapestry that describes the nature of one’s relationship to a place is unique for each individual. Those new to the study of place attachment have likely struggled with its multitude of terms and varying constructs – as some have warned, there are definitional inconsistencies. The person–process–place framework, however, showcases the diversity of definitions, and structures them into an organized, coherent framework that is based on empirical works from different disciplines. Thus, the concept of place attachment becomes more coherent, broad, and accessible. The person–process–place framework portrays the diversity of place attachment definitions that have accrued thus far, and offers a coherent structural alternative to the related concepts that previously remained scattered in the literature.

2.2 Methodologies: A multi-paradigmatic organizing framework The purpose of this section is to further organize the extant diverse research on place through a multi-paradigmatic approach. Patterson and Williams (2005) note that, since the 1990s, numerous authors have expressed concerns about the lack of conceptual clarity in research on place, and some authors have suggested that place research has failed to evolve into a systematic and coherent body of knowledge. Patterson and Williams (2005) believe such critiques do not adequately characterize the state of knowledge in place research, because responding to the issues raised requires investigating the epistemological foundations of place research traditions, enabling a pluralistic worldview that understands place not as a single research tradition, but as a domain of research informed by many disciplinary research traditions. Patterson and Williams (2005), consequently, introduce a framework for discussing epistemological foundations of research traditions and use it to characterize the body of place research, provide a clarifying response to critiques, and make a case for the value of diversity in thought. The aim of this section is to take the insight of Patterson and Williams (2005) one step further through a multiparadigmatic approach. Any explanation of place is based on a worldview. The premise of this section is that any worldview can be associated with one of the four broad paradigms: functionalist, interpretive, radical humanist, and radical structuralist. This section takes the case of place and discusses it from the four different

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viewpoints. It emphasizes that the four views expressed are equally scientific and informative; they look at the phenomenon from their certain paradigmatic viewpoint; and together they provide a more balanced understanding of the phenomenon under consideration. Each of the four following subsections provides a typical paradigmatic perspective that corresponds to one of the four paradigms. These different perspectives should be regarded as typical for each paradigm. The work of certain authors helps to define the logically coherent form of a certain typical perspective. But the work of many authors who share more than one perspective is located between the poles of the spectrum defined by the typical perspectives. The purpose of this section is not to put people into boxes. It is rather to recommend that a satisfactory perspective may draw upon several of the typical perspectives. The ancient parable of six blind scholars and their experience with the elephant illustrates the benefits of paradigm diversity. There were six blind scholars who did not know what the elephant looked like and had never even heard its name. They decided to obtain a mental picture (i.e. knowledge) by touching the animal. The first blind scholar felt the elephant’s trunk and argued that the elephant was like a lively snake. The second bind scholar rubbed along one of the elephant’s enormous legs and likened the animal to a rough column of massive proportions. The third blind scholar took hold of the elephant’s tail and insisted that the elephant resembled a large, flexible brush. The fourth blind scholar felt the elephant’s sharp tusk and declared it to be like a great spear. The fifth blind scholar examined the elephant’s waving ear and was convinced that the animal was some sort of a fan. The sixth blind scholar, who occupied the space between the elephant’s front and hid legs, could not touch any parts of the elephant and consequently asserted that there were no such beasts as elephants at all, accusing his colleagues of making up fantastic stories about non-existing things. Each of the six blind scholars held firmly to their understanding of an elephant and they argued and fought about which story contained the correct understanding of the elephant. As a result, their entire community was torn apart, and suspicion and distrust became the order of the day. This parable contains many valuable lessons. First, probably reality is too complex to be fully grasped by imperfect human beings. Second, although each person might correctly identify one aspect of reality, each may incorrectly attempt to reduce the entire phenomenon to their own partial and narrow experience. Third, the maintenance of communal peace and harmony might be worth much more than stubbornly clinging to one’s understanding of the world. Fourth, it might be wise for each person to return to reality and exchange positions with others to better appreciate the whole of the reality.2 Social theory can usefully be conceived in terms of four key paradigms: functionalist, interpretive, radical humanist, and radical structuralist. The four paradigms are founded upon different assumptions about the nature of social

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science and the nature of society. Each generates theories, concepts, and analytical tools which are different from those of other paradigms. Generally, the functionalist paradigm has provided the framework for current mainstream academic fields, and accounts for the largest proportion of theory and research in academia. In order to understand a new paradigm, theorists should be fully aware of assumptions upon which their own paradigm is based. Moreover, to understand a new paradigm one has to explore it from within, since the concepts in one paradigm cannot easily be interpreted in terms of those of another. No attempt should be made to criticize or evaluate a paradigm from the outside. This is self-defeating, since it is based on a separate paradigm. All four paradigms can be easily criticized and ruined in this way. These four paradigms are of paramount importance to any scientist, because the process of learning about a favored paradigm is also the process of learning what that paradigm is not. The knowledge of paradigms makes scientists aware of the boundaries within which they approach their subject. Each of the four paradigms implies a different way of social theorizing. Before discussing each paradigm, it is useful to look at the notion of “paradigm.” Burrell and Morgan (1979)3 regard the four paradigms as being defined by very basic meta-theoretical assumptions which underwrite the frame of reference, mode of theorizing and modus operandi of the social theorists who operate within them. It is a term which is intended to emphasize the commonality of perspective which binds the work of a group of theorists together in such a way that they can be usefully regarded as approaching social theory within the bounds of the same problematic. The paradigm does … have an underlying unity in terms of its basic and often “taken for granted” assumptions, which separate a group of theorists in a very fundamental way from theorists located in other paradigms. The “unity” of the paradigm thus derives from reference to alternative views of reality which lie outside its boundaries and which may not necessarily even be recognized as existing. (Burrell and Morgan 1979, pp. 23–24) Each theory can be related to one of the four broad worldviews. These adhere to different sets of fundamental assumptions about the nature of science (i.e., the subjective–objective dimension), and the nature of society (i.e., the dimension of regulation–radical change), as in Figure 2.2.4 Assumptions related to the nature of science are assumptions with respect to ontology, epistemology, human nature, and methodology. The assumptions about ontology are assumptions regarding the very essence of the phenomenon under investigation. That is, to what extent the phenomenon

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The Sociology of Radical Change

S U B J E C T I V E

Radical Humanist

Radical Structuralist

Interpretive

Functionalist

O B J E C T I V E

The Sociology of Regulation

Figure 2.2 The four paradigms Each paradigm adheres to a set of fundamental assumptions about the nature of science (i.e., the subjective–objective dimension), and the nature of society (i.e., the dimension of regulation–radical change)

is objective and external to the individual, or is subjective and the product of the individual’s mind. The assumptions about epistemology are assumptions about the nature of knowledge – about how one might go about understanding the world, and communicate such knowledge to others. That is, what constitutes knowledge, and to what extent it is something that can be acquired or is something that has to be personally experienced. The assumptions about human nature are concerned in particular with the relationship between individuals and their environment, which is the object and subject of social sciences. That is, to what extent human beings and their experiences are the products of their environment, or are the creators of their environment. The assumptions about methodology are related to the way in which one attempts to investigate and obtain knowledge about the social world. That is, to what extent the methodology treats the social world as being real, hard, and external to the individual, as being of a much softer, personal, and more subjective quality. In the former, the focus is on the universal relationship among elements of the phenomenon, whereas in the latter, the focus is on understanding of the way in which the individual creates, modifies, and interprets the situation that is experienced. The assumptions related to the nature of society are concerned with the extent of the regulation of society, or radical change in society.

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Sociology of regulation provides an explanation of society based on the assumption of its unity and cohesiveness. It focuses on the need to understand and explain why society tends to hold together rather than fall apart. Sociology of radical change provides an explanation of society based on the assumption of its deep-seated structural conflict, modes of domination, and structural contradiction. It focuses on the deprivation of human beings, both material and psychic, and it looks towards alternatives rather than acceptance of the status quo. The subjective–objective dimension and the regulation–radical change dimension together define four paradigms, each of which share common fundamental assumptions about the nature of social science and the nature of society. Each paradigm has a fundamentally unique perspective for the analysis of social phenomena. The aim of this section is not so much to create a new piece of the puzzle as to fit the existing pieces together in order to make sense of the whole. Each of the following sections first lays down the foundation by discussing one of the four paradigms, then provides a typical examination of place from the point of view of that paradigm. It should be noted that interest in people–place relations is growing. It represents all branches of the social sciences, including environmental psychology, sociology, community psychology, human geography, cultural anthropology, gerontology, demography, urban studies, leisure and tourism, ecology, forestry, architecture and planning, and economics. Since this topic has been researched quite broadly, it has been defined in a variety of ways, applied in a variety of contexts, and various terminologies have been used. The following discussion reflects this fact, which at times might seem confusing. 2.2.1 Functionalist paradigm This paradigm assumes that society has a concrete existence and follows a certain order. These assumptions lead to the existence of an objective and value-free social science that can produce true explanatory and predictive knowledge of the reality “out there.” It assumes scientific theories can be assessed objectively by reference to empirical evidence. Scientists do not see any role for themselves, within the phenomenon which they analyze through the rigor and technique of the scientific method. Thus, the paradigm attributes independence to the observer from the observed – that is, an ability to observe “what is” without affecting it. It assumes there are universal standards of science, which determine what constitutes an adequate explanation of what is observed. It assumes there are external rules and regulations governing the external world. The goal of scientists is to find the orders that prevail within that phenomenon. The functionalist paradigm seeks to provide rational explanations of social affairs and generate regulative sociology. It assumes a continuing order, pattern,

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and coherence and tries to explain what is. It emphasizes the importance of understanding order, equilibrium, and stability in society and the way in which these can be maintained. It is concerned with the regulation and control of social affairs. It believes in social engineering as a basis for social reform. The rationality that underlies functionalist science is used to explain the rationality of society. Science provides the basis for structuring and ordering the social world, similar to the structure and order in the natural world. The methods of natural science are used to generate explanations of the social world. The use of mechanical and biological analogies for modeling and understanding social phenomena is particularly favored. Functionalists are individualists. That is, the properties of the aggregate are determined by the properties of its units. Their approach to social science is rooted in the tradition of positivism. It assumes that the social world is concrete, meaning it can be identified, studied, and measured through approaches derived from the natural sciences. Functionalists believe the positivist methods that have triumphed in the natural sciences should also prevail in the social sciences. In addition, the functionalist paradigm has become dominant in academic sociology and mainstream academic fields. The social world is treated as a place of concrete reality, characterized by uniformities and regularities that can be understood and explained in terms of causes and effects. Given these assumptions, the individual is regarded as taking on a passive role; his or her behavior is being determined by the economic environment. Functionalists are pragmatic in orientation and are concerned to understand society so that the knowledge thus generated can be used in society. The functionalist paradigm is problem-oriented in approach, as it is concerned to provide practical solutions to practical problems. In Figure 2.2, the functionalist paradigm occupies the south-east quadrant. Schools of thought within this paradigm can be located on the objective– subjective continuum. From right to left they are: objectivism, social system theory, integrative theory, interactionism, and social action theory. The functionalist paradigm with respect to place The following study on lakeshore owners’ attitudes toward their properties by Jorgensen and Stedman (2001) is a typical application of the functionalist paradigm. Overview: Existing attempts to measure “sense of place” (SOP) are open to a number of different interpretations, some of which are well established in attitude research. Attitude theory can provide a basis for conceiving of SOP as cognitive, affective, and conative relationships with human environments. In this study, “sense of place” is defined as a multidimensional construct comprising: (1) beliefs about the relationship between self and place; (2) feelings toward the place; and (3) the behavioral exclusivity of the place in relation to alternatives. A 12-item SOP scale, consistent with a multidimensional theoretical prescription, is developed and subsequently tested in the field with a sample of

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lakeshore property owners in northern Wisconsin (n = 282). A number of measurement models based on attitude structure were posed as potential explanations of the scale’s construct validity. Results suggest that the SOP scale measured a general “sense of place” dimension that gained expression in property owners’ thoughts, feelings, and behavioral commitments for their lakeshore properties. This general evaluative dimension is more explanatory of observed responses than are the three univariate dimensions having interpretations consistent with place identity, place attachment, and place dependence. The dominance of the SOP factor over the narrower dimensions is prevalent in three different measurement models that posited both general and specific factors. Future research in this vein could be oriented towards reflecting the domains of attitude more closely, rather than being organized around the domains of sense of place as described in the literature.5 Introduction: There are a plethora of concepts describing the relationship between people and spatial settings, but “sense of place” (SOP) is perhaps the most general. In this research, an attitude framework is used to assess whether SOP encompasses place concepts commonly addressed in environmental psychology: Attachment, Identity, and Dependence. It is useful to consider sense of place as an attitude towards a spatial setting especially since the constructs noted above share strong similarities to the affective, cognitive, and conative components of attitude, respectively. An attitude approach offers place research a number of benefits: (1) organization of rather disorganized constructs, (2) linkage to established literature, and (3) established research methods. “Sense of place” has been referred to as an over-arching concept which subsumes other concepts describing relationships between human beings and spatial settings. In general, SOP is the meaning attached to a spatial setting by a person or group. A place can be regarded as a center of meaning or field of care that emphasizes human emotions and relationships. In addition, a place is much more than a point in space, but takes in the meanings which people assign to that landscape through the process of living in it. Accordingly, SOP is not imbued in the physical setting itself, but resides in human interpretations of the setting. Places can be represented as a confluence of cognitions, emotions, and actions organized around human agency. This recognizes that places can be conceptualized as an integrated system comprising three attitude domains. It can be further ventured that developing an understanding of the processes involved in the integration of these domains would enable stronger theoretical coherence between various threads of environmental psychology theory (e.g., environmental cognition and environmental evaluation). Similarly, greater coherence might be obtained across different place constructs by considering them within a tripartite framework comprising cognitive, affective, and conative processes. Three place constructs appear in the environmental psychology literature with some regularity: place identity, place attachment, and place dependence. There is a considerable degree of overlap among these concepts, but they have distinctive characteristics, also. Place identity involves those dimensions of self that define the individual’s personal identity in relation to the physical environment by means of a

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complex pattern of conscious and unconscious ideas, beliefs, preferences, feelings, values, goals and behavioral tendencies and skills relevant to this environment. As a cognitive structure, “place identity” is a substructure of a more global self-identification in the same way that one might consider gender identity and role-identity. Place attachment is described as a positive bond that develops between groups or individuals and their environment. It explicitly contains emotional content. Attachment can be regarded as the affective relationship between people and the landscape that goes beyond cognition, preference, or judgement. Alternatively regarded, attachment involves an interplay of affect and emotions, knowledge and beliefs, and behaviors and actions in reference to a place. Finally, place dependence can be defined as an occupant’s perceived strength of association between him- or her-self and specific places. This strength of association is not necessarily positive, based on “comparison level/comparison level for alternatives” model. This process involves a comparison of the current outcomes to those that would be obtained by selecting an alternative course of action. Each option may be negative; the chosen option may simply be the best among poor alternatives. In the literature, there is hardly universal agreement on the relationships among concepts. For example, place attachment subsumes or is subsumed by a variety of analogous ideas, including topophilia, place identity, insideness, genres of place, sense of place or rootedness, environmental embeddedness, community sentiment and identity. This research seeks to bring clarity to these relationships by testing the hypothesis that they can be represented as specific dimensions of the more general “sense of place.” The conceptual confusion noted above may in part be due to the diversity of approaches utilized in understanding SOP. The overall SOP theory and research can be divided into phenomenological and positivistic approaches. Positivistic research on SOP is characterized by researcher-defined variables, quantitative methods, and traditional hypothesis testing. In contrast, phenomenological approaches to understanding SOP address the intentional interaction between person and environment: the world of things, persons, and events as experienced by the individual. In phenomenology, concepts are treated holistically, and dissecting a multidimensional concept is a perilous business that may lead to losing the essence of the overall concept. Approaches to measuring sense of place: Perhaps owing in part to the phenomenological emphasis, empirical investigations of SOP utilizing quantitative methods have been relatively few in number until recently. However, these attempts have not reflected theoretical imperatives well, specifically the multidimensionality of the sense of place concept, as they range from unidimensional conceptions to those that explore potential multidimensionality. Towards an attitude-based conception of sense of place: Here it is suggested that empirical measures that attempt to incorporate multiple dimensions of SOP are more consistent with the theoretical strands of SOP. In addition, they

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should incorporate some theoretical imperative of how the different place concepts (identity, attachment, and dependence) interrelate. Place-related constructs can be regarded as attitudes. Attitude theory can therefore provide a theoretical framework for organizing the relationships between place components. The multidimensional foundation of SOP can correspond to different dimensions or components of attitude. Place attachment is equated with the affective (or emotional) component of attitude; place identity as the cognitive domain whereby a place is part of the social actor’s sense of self; and, place dependence represents the conative domain of attitude in which the dependence expressed for one’s setting is relative to the behaviors performed there. The question for the statistical test is whether the interrelationship between these components corresponds to conventional models of attitude structure. An attitude can be defined as a response to an exogenous event, object, or stimulus. Therefore, spatial settings may themselves serve as attitude objects. Further, affect, cognition, and behavior are three distinguishable components of response to an attitude object. Affect refers to emotional responses or activity in the sympathetic nervous system, as reflected in heart rate, galvanic skin response, or verbal self-reports. Beliefs, knowledge structures, precepts, and thoughts are all representative of the cognitive component of attitude. The conative component, in a tripartite view of attitude, includes reports of behavioral intentions and behavioral commitments, but not actual behavior. Sense of place measurement models: Like attitude, SOP is a hypothetical construct that is not accessible to direct observation, but can be inferred on the basis of measured responses. When conceived as an individual’s favorable or unfavorable attitude toward spatially demarcated object, SOP can be inferred from responses of a cognitive, affective, or conative nature. When each of these classes of response is regarded as being mediated by a distinct construct, the place concepts of identity, attachment, and dependence are evoked, respectively. Depending how the components of a model are related to each other, alternative models can be constructed and tested. Method: Data were collected through questionnaires which were sent to the residents of Eight Lakes in Vilas County (situated in the Northern Highlands Lake District of North Central Wisconsin). The three sense of place components were measured with twelve self-report items and 5-point Likert response scales ranging from “strongly disagree” to “strongly agree.” Results: A variance-covariance matrix was computed with bootstrapping so as to obtain the best estimates given the relatively small sample size. The inclusion of the asymptotic variances-covariances allowed the model parameters to be estimated without an assumption of multivariate normality. This method enabled the calculation of robust chi-squares and standard errors. Results suggest that the scale measures a general “sense of place” dimension that is expressed in property owners’ thoughts, emotions, and behavioral beliefs regarding their lakeshore

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properties. The dominance of the SOP factor over the narrower dimensions was prevalent in three different measurement models that posited both general and specific factors. 2.2.2 Interpretive paradigm This paradigm assumes that social reality is the result of the subjective interpretations of individuals. It sees the social world as a process that is created by individuals. Social reality, insofar as it exists outside the consciousness of any individual, is regarded as being a network of assumptions and intersubjectively shared meanings. This assumption leads to the belief that there are shared multiple realities which are sustained and changed. Researchers recognize their role within the phenomenon under investigation. Their frame of reference is one of participant as opposed to observer. The goal of interpretive researchers is to find the orders that prevail within the phenomenon under consideration; however, they are not objective. The interpretive paradigm is concerned with understanding the world as it is, at the level of subjective experience. It seeks explanations within the realm of individual consciousness and subjectivity. Its analysis of the social world produces sociology of regulation. Its views are underwritten by the assumptions that the social world is cohesive, ordered, and integrated. Interpretive sociologists seek to understand the source of social reality. They often delve into the depth of human consciousness and subjectivity in their quest for the meanings in social life. They reject the use of mathematics and biological analogies in learning about society, and their approach places emphasis on understanding the social world from the vantage point of the individuals who are actually engaged in social activities. The interpretive paradigm views the functionalist position as unsatisfactory, for two reasons. First, human values affect the process of scientific enquiry. That is, scientific method is not value-free, since the frame of reference of the scientific observer determines the way in which scientific knowledge is obtained. Second, in the cultural sciences the subject matter is spiritual in nature. That is, human beings cannot be studied by the methods of the natural sciences, which aim to establish general laws. In the cultural sphere, human beings are perceived as free. An understanding of their lives and actions can be obtained by the intuition of the total whole, which is bound to break down through the atomistic analysis of the functionalist paradigm. Cultural phenomena are seen as the external manifestations of inner experience. The cultural sciences, therefore, need to apply analytical methods based on understanding, through which the scientist can seek to understand human beings, their minds, and their feelings, and the way these are expressed in their outward actions. The notion of understanding is a defining characteristic of all theories located within this paradigm. The interpretive paradigm believes that science is based on taken-for-granted assumptions, and, like any other social practice, must be understood within a specific context. Therefore, it cannot generate objective and value-free knowledge. Scientific knowledge is socially constructed and socially sustained;

100 Place attachment its significance and meaning can be understood only within its immediate social context. The interpretive paradigm regards mainstream academic theorists as belonging to a small and self-sustaining community, which believes that social reality exists in a concrete world. They theorize about concepts that have little significance to people outside the community, which practices social theory, and the limited community which social theorists may attempt to serve. Mainstream academic theorists tend to treat their subject of study as a hard, concrete, and tangible empirical phenomenon that exists “out there” in the “real world.” Interpretive researchers are opposed to such structural absolution. They emphasize that the social world is no more than the subjective construction of individual human beings who create and sustain a social world of intersubjectively shared meaning, which is in a continuous process of reaffirmation or change. Therefore, there are no universally valid rules of science. Interpretive research enables scientists to examine human behavior together with ethical, cultural, political, and social issues. In Figure 2.2, the interpretive paradigm occupies the south-west quadrant. Schools of thought within this paradigm can be located on the objective– subjective continuum. From left to right they are: solipsism, phenomenology, phenomenological sociology, and hermeneutics. The interpretive paradigm with respect to place The following study on the social construction of nature and the environment through landscapes by Greider and Garkovich (1994) is a typical application of the interpretive paradigm. A theoretical framework is provided here to understand a cultural group’s definition of and relationship with place, in general, and the nature and the environment, in particular. The framework defines “landscape” as the symbolic environment created by a human act of conferring meaning on the nature and the environment. This landscape reflects the self-definitions of the people within a particular cultural context. The transformation of the physical environment into landscape reflects people’s definitions of themselves and on how these landscape are reconstructed in response to people’s changing definitions of themselves.6 Every river is more than just one river. Every rock is more than just one rock. Why does a real estate developer look across an open field and see comfortable suburban ranch homes nestled in quiet cul-desacs, while a farmer envisions endless rows of waving wheat and a hunter sees a five-point buck cautiously grazing in preparation for the coming winter? The open field is the same physical thing, but it carries multiple symbolic meanings that emanate from the values by which people define themselves. The real estate developer, the farmer, the hunter are definitions of who people are, and the natural environment – the physical entity of the open field – is transformed symbolically to reflect these self-definitions. These symbolic meanings and definitions are sociocultural phenomena, not physical phenomena, and they transform the open field into a symbolic landscape.

Place attachment 101 “Landscapes” are the symbolic environments created by human acts of conferring meaning to the nature and the environment, of giving the environment definition and form from a particular angle of vision and through a special filter of values and beliefs. Every landscape is a symbolic environment. These landscapes reflect our self-definitions that are grounded in culture. Our understanding of the nature and of the human relationships with the environment are really cultural expressions used to define who we were, who we are, and who we hope to be at this place and in this space. Landscapes are the reflection of these cultural identities, which are about us, rather than the natural environment. When attempting to identify and understand the potential human consequences of changes in the natural environment, it is imperative that these consequences arc understood from the many cultural definitions that create landscapes. Is the landscape created by the real estate developer, the farmer, or the hunter? Actually, any physical place has the potential to embody multiple landscape each of which is grounded in the cultural definitions of those who encounter that place. Every river is more than just one river. Every rock is more than just one rock. Cultural groups transform the natural environment into landscapes through the use of different symbols that bestow different meanings on the same physical object or condition. These symbols and meanings arc sociocultural phenomena; they arc social constructions, and they result from ongoing negotiations in a cultural context. Of course, humans reside in a natural world that is “there,” but this world is meaningless. Meanings are not inherent in the nature of things. Instead, the symbols and meanings that comprise landscapes reflect what people in cultural groups define to be proper and improper relationships among themselves and between themselves and the physical environment. An example may help illustrate how landscapes are the reflection of sociocultural symbols and meanings that define what it means to be a human being in a particular culture. In Lexington, Kentucky, the great thoroughbred estate of Calumet Farm had fallen on hard times. The estate had been the home of many world champions and had come to symbolize the place of Lexington in the international world of the “sport of kings.” Local people expressed great concern that the estate would be subdivided and developed as a residential housing or a shopping mall. The local government began to consider expensive schemes to save this locally important site. Every major metropolitan newspaper in the country reported that Calumet Farm – the home of internationally famous thoroughbreds and the heart of the Bluegrass horse country – would be put on the auction block. A collective sigh of relief and a standing ovation greeted the new owner of Calumet when he proclaimed that he intended to change not a single blade of grass. For many people of the Bluegrass and thoroughbred breeders, something much more, something qualitatively different from just a farm, was saved that day. The symbolic representation of a collective local history – the essence of a collective self-definition that has dominated the region for generations and was embodied in the landscape of Calumet Farm – had been saved. What this and other

102 Place attachment landscape examples suggest is that the definitions of the nature and the environment are grounded in various symbols through which cultural groups transform the nature and the world that is “there” into meaningful subjective phenomena. To understand human relationships with the natural environment, the subjective symbols and meanings through which a group of people socially constructs the landscape must be described. Natural phenomena are sociocultural phenomena in the sense that they are constructed through social interactions among members of a culture as they negotiate the meanings of the nature and the environment. Various conceptions of nature are created from different social and cultural contexts and the nature then becomes indistinguishable from that context. Each culture constructs its own world out of the infinite variety of nature. Nature is socialized, reorganized, and made into a material manifestation of social structure. The natural environment is transformed into culturally meaningful phenomena and then is viewed from the perspective of these cultural definitions. A sociocultural group constructs a landscape from the nature and the environment through culturally meaningful symbols and then reifies it. Shared, taken-for-granted, and reified symbols and meanings that emerge through processes of negotiation thus define social and natural phenomena and the situations in which they are located. These intersubjectivc definitions of the situation, rather than the situations per se, constitute reality for the group of people. Cultural groups continue to reconstruct and redefine their realities – past, present, and future – through ongoing social interactions, which may be thought of as negotiations over meaning, that reinforce and change the symbols, meanings, and definitions of the situation. Symbols and their meanings change over time, but they have a persistence that gives them long-term continuity. Human societies have experienced natural and social calamities – earthquakes, volcanic eruptions, hurricanes, wars, riots – since the beginning of time, but with a core of continuity, survival, and reconstruction evident. It is the use of systems of symbols that makes this core possible. Thus, understanding symbol systems is essential to understand relationships between human societies, nature, and the environment. How can a landscape persist and sustain a core understanding of human-natural environment relations among a group of people in the face of technological, economic, and other changes? Lying beneath what is the relatively observable worldview of a culture is a structure of beliefs that is shared in a community. These are shared convictions of what is the proper form of a system of values. This structure of beliefs is comprehensive and is so taken for granted, so implicitly obvious to the individual, that it is indistinguishable from the person’s self-definition. It is here, then, in the structure of beliefs that the most tenacious, most significant symbols are embedded and maintained. Overlaying this structure are superficial manifestations of the structure of beliefs and these manifestations are quite changeable. New technologies or other externally introduced changes may represent such superficial manifestations and may be voluntarily incorporated into the lives of people in ways that

Place attachment 103 enhance or, at a minimum, do not contradict their self-definitions and takenfor-granted relationships to each other and to their landscapes. The belief structure is something that people bring to a new situation that needs definition and provides a context within which negotiations over the meaning of the situation occur. Thus, the more durable traditional symbols and beliefs provide people with an interpretive framework – a familiar context – within which they can construct the meanings of new technologies and other changes. Cultural groups use symbols to define the natural environment and fit it into their ongoing, everyday, taken-for-granted worlds within which they organize both their relationships to each other and their relationships with the environment. The natural environment is transformed through symbols and concepts that organize peoples’ relationships in the social world. The natural environment as a symbolic social construction is reified by the sociocultural group. Reification implies that humans are capable of forgetting their own authorship of the human world. Human meanings are no longer understood as world-producing but as being, in their turn, products of the “nature of things.” As such, the symbolic social constructions – and here the landscape is included – become part of the world taken for granted. Members of the group act with the intuitive knowledge that their relationships to the natural environment could be no other way. Ideas and the realities they inform are naturally and indissolubly bound up together. Cultural groups socially construct landscapes as reflections of themselves. In the process, the social, cultural, and natural environments are meshed and become part of the shared symbols and beliefs of the groups. Taken together, these perspectives suggest that individuals perceive and categorize that which is given – the social and natural environment – in terms of intersubjective, taken-for-granted symbols and meanings and thereby define the situations in which they are located. These definitions of the situations constitute reality for those who share these meanings. As the context changes – as environmental change occurs, for example – there is no inherent meaning to the change. Instead, people negotiate the meaning of the contextual or environmental change as a reflection of their changing definitions of themselves. In this sense, then, the nature and the environment are socially and culturally constructed through these social processes and become landscapes through social interaction and negotiation. 2.2.3 Radical humanist paradigm The radical humanist paradigm provides critiques of the status quo and is concerned to articulate, from a subjective standpoint, the sociology of radical change, modes of domination, emancipation, deprivation, and potentiality. Based on its subjectivist approach, it places great emphasis on human consciousness. It tends to view society as anti-human. It views the process of reality creation as feeding back on itself, such that individuals and society are prevented from reaching their

104 Place attachment highest possible potential. That is, the consciousness of human beings is dominated by the ideological superstructures of the social system, which results in their alienation or false consciousness. This, in turn, prevents true human fulfillment. The social theorist regards the orders that prevail in society as instruments of ideological domination. The major concern for theorists is with the way this occurs, and finding ways in which human beings can release themselves from constraints that existing social arrangements place upon realization of their full potential. They seek to change the social world through a change in consciousness. Radical humanists believe that everything must be grasped as a whole, because the whole dominates the parts in an all-embracing sense. Moreover, truth is historically specific, relative to a given set of circumstances, so that one should not search for generalizations for the laws of motion of societies. The radical humanists believe that the functionalist paradigm accepts purposive rationality, logic of science, positive functions of technology, and neutrality of language, and uses them in the construction of “value-free” social theories. The radical humanist theorists intend to demolish this functionalist structure, emphasizing its political and repressive nature. They aim to show the role that science, ideology, technology, language, and other aspects of the superstructure play in sustaining and developing the system of power and domination, within the totality of the social formation. Their function is to influence the consciousness of human beings for eventual emancipation and formation of alternative social formations. The radical humanists note that functionalist sociologists create and sustain a view of social reality which maintains the status quo and which forms one aspect of the network of ideological domination of society. The radical humanists’ focus on the “superstructural” aspects of society reflects their attempt to move away from the economism of orthodox Marxism and emphasize Hegelian dialectics. It is through a dialectic that the objective and subjective aspects of social life interact. The superstructure of society is believed to be the medium through which the consciousness of human beings is controlled and molded to fit the requirements of the social formation as a whole. The concepts of structural conflict, contradiction, and crisis do not play a major role in this paradigm, because these more objectivist views of social reality fall within the radical structuralist paradigm. The main concerns of the radical humanist paradigm are the concepts of consciousness, alienation, and critique. In Figure 2.2, the radical humanist paradigm occupies the north-west quadrant. Schools of thought within this paradigm can be located on the objective–subjective continuum. From left to right they are: French existentialism, anarchistic individualism, and critical theory. The radical humanist paradigm with respect to place The following study on languages of place and discourses of power by Stokowski (2002) is a typical application of the radical humanist paradigm.

Place attachment 105 The concept of “sense of place” typically is used to refer to an individual’s ability to develop feelings of attachment to particular settings based on combinations of use, attentiveness, and emotion. Despite the assumed positive values of a sense of place, critics point out that places are more than simply geographic sites – they are also fluid, changeable, dynamic contexts of social interaction and memory, and they “contain” overt and covert social practices that embed in place-making behaviors notions of ideology, power, control, conflict, dominance, and distribution of social and physical resources. This section traces emerging scholarship about sense of place as a social construction, and offers examples from leisure, outdoor recreation, and tourism development. Place and sense of place are seen as socially constructed, always in the process of being created, always provisional and uncertain, and always capable of being discursively manipulated towards desired (individual or collective) ends. A research program about leisure and the politics of place awaits development, but should focus on language and discourse, and should begin with the question: how are leisure places socially constructed with political consequences?7 We must be insistently aware of how space can be made to hide consequences from us, how relations of power and discipline are inscribed into the apparently innocent spatiality of social life, how human geographies become filled with politics and ideology. There is a need to refer to the broadest possible range of overt and covert social practices that embed in place-making behaviors notions of ideology, power, control, conflict, dominance, and distribution of social and physical resources. Interpretive and critical scholars in all disciplines charge that traditional approaches cannot account for sites that are not physically present. For example, how should place be defined when technological advances allow the creation of cyber and hyper “sites” that are invisible or even imaginary, where power relations between and among participants are unclear, and where rules of social engagement are uncertain? Many other questions about place and sense of place are introduced: How are place meanings incorporated into management decisions? What are the social and political consequences of different versions of place realities? Which spokespersons are allowed to define place boundaries, or tell the histories of place, or interpret the meanings of place? How do different conceptions of place exert influence on people and groups? How is place manipulated for social good or evil? With these types of questions, the politics of place assume dimensions that go well beyond basic managerial concerns. Because the significance of place emerges through interaction with others, language is central in formation of a sense of place. Place affiliations are sustained by rhetorical (i.e., persuasive) uses of language, with participants using stylistic devices such as icons, imagery, argumentation, symbols, and metaphors, among others. The derived symbols of place are formalized through use into coherent language structures and appear to people as narratives, myths, fables, and the like. One of the most common of these forms is the place narrative.

106 Place attachment The social and cultural values of place become sustained in the language, culture, and history collectively experienced, imagined, and remembered across groups and communities of people. The tasks of place-making – opening the dialogic space, confirming and interrogating contexts, and framing action – are inherently political and moral acts. While any given text may appear to be logical and convincing to some groups of people, others may be offended or unmoved by its claims. Thus, texts also function symbolically to distance groups or individuals from one another. Understanding the social construction of place and sense of place refocuses thinking away from the taken-for-granted physical characteristics of space, and toward the possibility that places are always in the process of being created, always provisional and uncertain, and always capable of being discursively manipulated towards desired (individual or collective) ends. Such conclusions lead directly into analysis of the politics of place. Places structure a normative landscape – the way in which ideas about what is right, just, and appropriate are transmitted across people. But value and meaning are not inherent in any space or place – indeed they must be created, reproduced, and defended from heresy. Each effort to create place becomes an elaboration of the beliefs and values of some collection of people, expressed and fostered in their promotion of a preferred reality. The act of “making places” appears to be such a natural human function, though, that many of the assumptions and social practices that go into it are unobtrusive, often hidden to most participants. While one should not assume that unobtrusive social practices are inherently subversive or exploitive, no explicit guidelines exist for evaluating the claims of place making. This may be problematic, particularly for activities that involve reconstructing spaces in the “public” interest. One way to deconstruct the activities of place-making is to evaluate the communicative practices used by social actors in advancing their positions. These social behaviors include the use of language and non-verbal imagery in bounding, focusing, and limiting discussion topics; the use of verbal or non-verbal strategies to include or deny participation; and the manipulation of symbols to achieve desired ends. These behaviors, and many others, are circumscribed by the levels of power available to social actors. People have differential levels of access and different skills and abilities relative to participation in public debate and discussion. It is not possible to understand the construction of meaning without attention to the means by which local and non-local groups (colonizers, wealthy urban classes, and so forth) can exercise widespread political and economic control over the countryside by separating public and private resources, by managing the issue agendas discussed in public arenas, or by investing economically in certain interests. New models of deliberative democracy emerging in planning, social policy, and critical theory incorporate issues of power as a central concern. Many authors writing about deliberative practices and democratic participation draw from Habermas’ (1987) theory of communicative action, a theory that conceptualizes social action as emerging from interpersonal agreements created in language practices.

Place attachment 107 Discourses – the stable, situated, ritualized languages that arise – reflect the cultural and organizational structures of the social worlds which produce them, and offer seemingly rational perspectives for viewing individual and institutional behaviors. The utility of discursive models of democracy is in their ability to critique language practices, and in the hopes that they may foster less politicized, more civic, and more democratic approaches toward collaborative learning, public participation in environmental affairs, and lessening social conflicts. If place is to be conceived as socially constructed, then new types of research are needed to understand the politics of place in leisure, recreation, and tourism. The prevailing discourses of leisure – formed around notions of freedom, self-expression, and personal enjoyment – serve to encourage individualism, but these also simultaneously camouflage the political agendas and orientations of participants, managers, and legislating bodies. A full research program about leisure and the politics of place awaits development, but should begin with the question: how are leisure places socially constructed with political consequences? The politics of place in tourism tend to be hidden behind a pervasive discourse about the assumed economic benefits of destination development, a point made evident in many tourism case studies. For example, an analysis of the invention of New England as a tourist region, reveals how tourist industries brought natural scenery, leisure time, history, and even childhood memories and personal ancestry into the world of market transactions. Tourism development complicates issues of ownership of community history and memory; tourism also reduces all types of interactions to functional exchange values. But not all tourism place issues are cause for cynicism. Ideally, community discussion and public involvement processes can be marshaled to reveal and develop the important social and cultural qualities of place. An example is the tourism development in the island town of Manteo, North Carolina. In an effort to guide tourism development processes there, townspeople engaged in a process of identifying significant community places of social interaction and meaning. It was noted that attentiveness to a town’s “sacred structure” – defined as the most highly valued places in a community’s common landscape – could produce a better plan for tourism design and development. Not all the places listed as sacred were striking, exotic, or quaint; they were, instead, humble places that provided settings for the community’s daily routine. Understanding the role of these settings in forming a communal sense of place – places protected both community and individual identity – reduced the political maneuvering often associated with tourism development. Understanding the politics of place in leisure requires knowledge beyond the objective qualifies of places; it also requires knowledge of foundational processes related to the social construction of place. To understand “one’s own place in the world” requires basic factual knowledge about the physical setting, as well as a more abstract understanding of how place is organized and confirmed socially and culturally.

108 Place attachment Research about the politics of place must advance into analyses of the presentation, evaluation, and negotiation of divergent place discourses created by people engaged in social interaction. Under this research agenda, it will become clear that what is visible “on the ground” at any given time is only the working out of one version of reality, promoted by a set of social actors who have succeeded in using their power and position to advance their own ideals. Beyond these topics, research is also needed about how groups are successful in making place claims, as well as about the circumstances under which individuals and groups fail in their efforts, and the planning mechanisms that may be employed to ensure justice and equity in place management. Much can also be learned from studying histories of the past – as the past once happened, and as it re-happens in the discourses of retrospection and memory – in terms of how narratives of place have traditionally supported or constrained community affiliation, personal identity and civic culture. Such a research agenda has at its heart a critical tendency working towards making a better society for all citizens. 2.2.4 Radical structuralist paradigm The radical structuralist paradigm assumes that reality is objective and concrete, as it is rooted in the materialist view of natural and the social world. The social world, similarly to the natural world, has an independent existence, that is, it exists outside the minds of human beings. Sociologists aim at discovering and understanding the patterns and regularities that characterize the social world. Scientists do not see any role for themselves in the phenomenon under investigation. They use scientific methods to find the order that prevails in the phenomenon. This paradigm views society as a potentially dominating force. Sociologists working within this paradigm have an objectivist standpoint and are committed to radical change, emancipation, and potentiality. In their analysis they emphasize structural conflict, modes of domination, contradiction, and deprivation. They analyze the basic interrelationships within the total social formation, and emphasize the fact that radical change is inherent in the structure of society, and takes place through political and economic crises. This radical change necessarily disrupts the status quo and replaces it by a radically different social formation. It is through this radical change that the emancipation of human beings from the social structure is materialized. For radical structuralists, an understanding of classes in society is essential for understanding the nature of knowledge. They argue that all knowledge is classspecific; that is, it is determined by the place one occupies in the productive process. Knowledge is more than a reflection of the material world in thought; it is determined by one’s relation to that reality. Since different classes occupy different positions in the process of material transformation, there are different kinds of knowledge. Hence, class knowledge is produced by and for classes, and exists in a struggle for domination. Knowledge is thus ideological; that is, it formulates views of reality and solves problems from class points of view.

Place attachment 109 Radical structuralists reject the idea that it is possible to verify knowledge in an absolute sense through comparison with socially neutral theories or data. But they emphasize the possibility of producing a “correct” knowledge from a class standpoint. They argue that the dominated class is uniquely positioned to obtain an objectively correct knowledge of social reality and its contradictions. It is the class with the most direct and widest access to the process of material transformation that ultimately produces and reproduces that reality. Radical structuralists’ analysis indicates that the social scientist, as a producer of class-based knowledge, is a part of the class struggle. Radical structuralists believe truth is the whole, and emphasize the need to understand the social order as a totality rather than as a collection of small truths about various parts and aspects of society. The financial empiricists are seen as relying almost exclusively upon a number of seemingly disparate, datapacked, problem-centered studies. Such studies, therefore, are seen as irrelevant exercises in mathematical methods. This paradigm is based on four central notions. First, the notion of totality: All theories address the total social formation. This notion emphasizes that the parts reflect the totality, not the totality the parts. Second, the notion of structure: The focus is on the configurations of social relationships, called structures, which are treated as persistent and enduring concrete facilities. Third, the notion of contradiction: Structures, or social formations, contain contradictory and antagonistic relationships within them which act as seeds of their own decay. Fourth, the notion of crisis: Contradictions within a given totality reach a point at which they can no longer be contained. The resulting political, economic crises indicate the point of transformation from one totality to another, in which one set of structures is replaced by another of a fundamentally different kind. In Figure 2.2, the radical structuralist paradigm occupies the north-east quadrant. Schools of thought within this paradigm can be located on the objective–subjective continuum. From right to left they are: Russian social theory, conflict theory, and contemporary Mediterranean Marxism. The radical structuralist paradigm with respect to place The following study on the Marxian theory of capitalist accumulation: in the light of geography by Harvey (1975a) is a typical application of the radical structuralist paradigm. Marx recognizes that capital accumulation takes place in a spatial context and that it in turn creates specific kinds of spatial structures. Marx further develops a novel approach to location theory and shows that it is possible to connect,

110 Place attachment theoretically, the general processes of economic growth with an explicit understanding of an emergent structure of spatial relationships.8 Marx’s theory of growth under capitalism places accumulation of capital at the center of things. Accumulation is the engine which powers growth under the capitalist mode of production. The capitalist system is therefore highly dynamic and inevitably expansionary; it forms a permanently revolutionary force which continuously and constantly reshapes the world we live in. A stationary state of simple reproduction is, for Marx, logically incompatible with the perpetuation of the capitalist mode of production. The historical mission of the bourgeoisie is accumulation for accumulation’s sake, and production for production’s sake. Yet this historical mission does not stem from the inherent greed of the capitalist; it arises, rather, out of forces entirely independent of the capitalist’s individual will. Economic growth under capitalism is a process of internal contradictions which frequently erupt as crises. Harmonious or balanced growth under capitalism is, in Marx’s view, purely accidental because of the spontaneous and chaotic nature of commodity production under competitive capitalism. Marx’s analyses of this system of commodity production led him to the view that there are innumerable possibilities for crises to occur, and that certain tendencies inherent within capitalism are bound to produce serious stresses within the accumulation process. Marx makes the proposition that the circulation of capital realizes value while living labor creates value. Circulation has two aspects; the actual physical movement of commodities from point of production to point of consumption, and the actual or implicit costs that attach to the time taken up and to the social mediations (the chain of wholesalers, retailers, banking operations, and the like) which are necessary in order for the produced commodity to find its ultimate user. Marx regards the former as integral to the production process, and therefore, productive of value. The latter are regarded as necessary costs of circulation which are not, however, productive of value – they are to be regarded, therefore, as necessary deductions out of surplus, because the capitalist has to pay for them. The transportation and communications industry which “sells change in location” is directly productive of value because, economically considered, the spatial condition, the bringing of the product to market, belongs to the production process itself. The product is really finished only when it is on the market. However, the means of transportation and communication, because they are made up almost entirely of fixed capital, have their own peculiar laws of realization – laws which stem from the fact that transportation is simultaneously produced and consumed at the moment of its use. Although the transport industry is potentially a source of surplus value, there are good reasons for capital not to engage in its production except under certain favorable circumstances. The state is often, therefore, very active in this sphere of production. The cost of transportation is important insofar as the expansion of the market and the exchangeability of the product are connected with it. Prices, both of raw materials and finished goods, are sensitive to the costs of transportation and the ability to draw in raw materials over long distances. Furthermore, to

Place attachment 111 dispatch the finished product to a distant market is obviously affected by these costs. The costs of circulation can be reduced by improved, cheaper, and more rapid transportation. One byproduct of this is a cheapening of many elements of constant capital (raw material inputs) and the extension of the geographic market. Viewed from the standpoint of production as a totality, the reduction of the costs of real circulation in space belongs to the development of the forces of production by capital. Placed in the context of accumulation in general, improvements in transportation and communication are seen to be inevitable and necessary. The revolution in the modes of production of industry and agriculture made necessary a revolution in the means of communication and transport so that they became gradually adapted to the modes of production of mechanical industry, by the creation of a system of river steamers, railways, ocean steamers and telegraphs. The imperative to accumulate, consequently, implies the imperative to overcome spatial barriers. The capitalist mode of production promotes the production of cheap and rapid forms of communication and transportation in order that the direct product can be realized in distant markets in mass quantities at the same time as new spheres of realization for labor, driven by capital can be opened up. The reduction in realization and circulation costs helps to create, therefore, fresh room for capital accumulation. Put the other way around, capital accumulation is bound to be spatially expansionary and to be so by progressive reductions in the costs of communication and transportation. The opening up of more distant markets, new sources of raw materials and of new opportunities for the employment of labor under the social relations of capitalism, has the effect, however, of increasing the turnover time of capital unless there are compensating improvements in the speed of circulation. The turnover time of a given capital is equal to the production time plus the circulation time. The longer the turnover time of a given capital, the smaller is its annual yield of surplus value. More distant markets tie capital up in the circulation process for longer time periods, and therefore, have the effect of reducing the realization of surplus value for a particular capital. By the same token, any reduction in circulation time increases surplus production and enhances the accumulation process. Speeding up the velocity of circulation of capital contributes to the accumulation process. Under these conditions even spatial distance reduces itself to time: the important thing is not the market’s distance in space, but the speed with which it can be reached. There is, thus, a strong incentive to reduce the circulation time to a minimum for to do so is to minimize the wandering period of commodities. A dual need, both to reduce the cost and the time involved in movement, thus emanates from the imperative to accumulate. Long distance trade, because it separates production and realization by a long time interval, may still be characterized by a long turnover period and a lack of continuity in the employment of capital. This kind of trade, and overseas commerce in general, thus, forms one of the material bases and one of the

112 Place attachment sources of the credit system. The credit system allows of a spatial extension of the market by establishing continuity where there was none before. The necessity to annihilate space by time can in part be compensated for by an emerging system of credit. The need to minimize circulation costs as well as turnover times promotes agglomeration of production within a few large urban centers which become, in effect, the workshops of capitalist production. The “annihilation of space by time” is here accomplished by a “rational” location of activities with respect to each other so as to minimize the costs of movement of intermediate products in particular. Along with this concentration of masses of men and capital, thus accelerated at certain points, there is the concentration of these masses of capital in the hands of the few. The ability to economize on circulation costs depends, however, on the nature of the transportation relations established, and, here, there appears to be a dynamic tendency towards concentration. Spatial expansion and spatial concentration are both to be regarded as the product of the same striving to create new opportunities for capital accumulation. In general, it appears that the imperative to accumulate produces concentration of production and of capital at the same time as it creates an expansion of the market for realization. As a consequence, “flows in space” increase remarkably, while the market expands spatially, and the periphery in relation to the center is circumscribed by a constantly expanding radius. Some sort of center-periphery relation is bound to arise out of the tension between spatial concentration and spatial expansion. Since the structure of transport facilities does not remain constant, we find a shifting and relocation of places of production and of markets as a result of changes in their relative positions caused by the transformation in transport facilities. These transformations alter the relative distances of places of production from the larger markets and consequently bring about the deterioration of old and the rise of new centers of production. The drive to overcome spatial barriers and to annihilate space with time is designed to counteract what Marx saw as a pervasive tendency under capitalism for the profit rate to fall. The creation of built environments in the service of capitalism means a growth of that portion of social wealth which, instead of serving as direct means of production, is invested in means of transportation and communication and in the fixed and circulating capital required for their operation. Investment in the means of transportation is bound to increase the organic composition of social capital which tends to generate a fall in the rate of profit at the same time as its effects are supposed to increase the rate of profit. The capitalist development has to negotiate a knife-edge between these two contradictory tendencies. The virtue of these analyses lies not in their sophistication. It lies, rather, in the way in which they can be tightly integrated into the fundamental insights into the production of value and the dynamics of accumulation. The Marxian theory commences with the dynamics of accumulation and seeks to derive out of this analysis certain necessities with respect to spatial structures. The landscape which capitalism creates is also seen as the locus of contradiction and

Place attachment 113 tension, rather than as an expression of harmonious equilibrium. And crises in fixed capital investments are seen as synonymous in many respects with the dialectical transformation of space. The Marxian theory teaches us how to relate, theoretically, accumulation and the transformation of spatial structures and ultimately, of course, it provides us with the kind of theoretical and material understanding which will allow us to understand the reciprocal relationships between space and history.

2.3 Conclusion The topic of place attachment has been examined in many fields of study, and therefore it has been conceptually defined, and methodologically approached, in various different ways. Some people regard this situation as chaotic, and that some organizing frameworks would be helpful. In this chapter, Section 2.1 discussed a tripartite framework for organizing definitions, and Section 2.2 provided a multi-paradigmatic framework for organizing methodologies. In Section 2.1 it was noted that place attachment has been researched quite broadly, and so has been defined in a variety of ways. The various definitions of the concept can be synthesized into a three-dimensional person–process–place organizing framework. The person dimension of place attachment refers to its individually or collectively determined meanings. The psychological process dimension includes the affective, cognitive, and behavioral components of attachment. The place dimension emphasizes the place characteristics of attachment, including spatial level, specificity, and the prominence of social or physical elements. The framework organizes related place attachment concepts and thus clarifies the term. Section 2.2 briefly discussed four views expressed with respect to place. The functionalist paradigm believes that place has characteristics that can be modeled, measured, and statistically tested. The interpretive paradigm believes that place is socially constructed. The radical humanist paradigm believes that the social construction of place reflects the preferences of interest groups. The radical structuralist paradigm believes that place is class-determined. Each paradigm is logically coherent in terms of its underlying assumptions, conceptualizes and studies the phenomenon in a certain way, and generates distinctive kinds of insight and understanding. Therefore, different paradigms in combination provide a broader understanding of the phenomenon under consideration. An understanding of different paradigms leads to a better understanding of the multi-faceted nature of the phenomenon.

Notes 1 For this literature, see Altman (1975), Aronson et al. (2005), Bartlett (1932), Billig (2006), Bonaiuto, Breakwell, and Cano (1996), Brewer (1991), Brown, Perkins, and Brown, (2003), Case (1996), Cuba and Hummon (1993), Deutsch (2005), Dovey (1985), Feldman (1990), Francaviglia (1978), Fried (1963, 2000), Fullilove (1996), Gans (1962), Geipel (1982), Giuliani (2003), Giuliani and Feldman (1993), Hay (1998), Hidalgo and Hernandez (2001), Hummon (1992), Hunter (1974, 1978),

114 Place attachment

2 3 4 5

6

7

8

Jorgensen and Stedman (2001), Kates et al. (1977), Kasarda and Janowitz (1974), Lalli (1992), Low (1992), Low and Altman (1992), Manzo (2003, 2005), Markus (1977), Mazumdar and Mazumdar (2004), McMillan and Chavis (1986), Mesch and Manor (1998), Michelson (1976), Nasar and Julian (1995), Perkins and Long (2002), Pretty, Chipuer, and Bramston (2003), Proshansky (1978), Proshansky and Fabian (1987), Relph (1976), Riemer (2004), Riger and Lavrakas (1981), Riley (1992), Rubenstein and Parmelee (1992), Sanders, Bowie, and Bowie (2003), Scannell and Gifford (2010), Stokols and Shumaker (1981), Tuan (1974), Twigger-Ross and Uzzell (1996), Uzzell, Pol, and Badenas (2002), Virden and Walker (1999), Vorkinn and Riese (2001), Williams et al. (1992), Woldoff (2002), and Young and Willmott (1962). Section 2.1 of this chapter is based on Scannell and Gifford (2010). This parable is taken from Steger (2002). This work borrows heavily from the ideas and insights of Burrell and Morgan (1979). See Burrell and Morgan (1979) for the original work. For this literature, see Anderson, Basilevsky, and Hum (1983), Cuba and Hummon (1993), Gieryn (2000), Jorgensen and Stedman (2001), Kaltenborn (1998), Krupat (1983), Lalli (1992), McAndrew (1998), Pretty et al. (2003), Rudzitis (1993), Shamai (1991), Shields (1991), Shumaker and Taylor (1983), Stedman (1999, 2002, 2003a, 2003b), and Vorkinn and Riese (2001). This section is based on Jorgensen and Stedman (2001). For this literature, see Alexander (2002), Alkon and Traugot (2008), Brandenburg and Carroll (1995), Burley (2007), Buttimer (1980), Eisenhauer, Krannich, and Blahna (2000), Fishwick and Vining (1992), Franck (1987), Freudenburg, Frickel, and Gramling (1995), Greider and Garkovich (1994), Gustafson (2001), Kunstler (1993), Lewis (1979), Milligan (1998), Norberg-Schultz (1979), Peet (1999), Relph (1970, 1976, 1997), Sack (1980), Seamon (1980, 1982, 1987, 1993, 2000, 2002), Tuan (1974, 1975, 1977), and Williams (2000). This section is based on Greider and Garkovich (1994). For this literature, see Cheng, Kruger, and Daniels (2003), Cowley (1989), Cresswell (2004), Davis and Henley (1990), Freudenburg and Gramling (1992), Gibbs (1990), Greider and Garkovich (1994), Greider and Little (1988), Harvey (1996), Jorgensen (1984), Lewis (1989), Massey (2004), Mitchell (2003), Mitchell et al. (1993), Petrzelka (2004), Ridington (1982), Salamon (1980, 1984, 1985a, 1985b), Salamon and O’Reilly (1979), Schroeder (2000), Soja (1989, 1996), Stoffle et al. (1990, 1991), Stokowski (2002), Tuan (1991), Whittemore (1992), Williams (2002), and Williams and Van Patten (1998). This section is based on Stokowski (2002). For this literature, see Amin (1973), Baran (1957), Barratt Brown (1974), Emmanuel (1972), Fanon (1967), Frank (1969), Harvey (1975a, 1975b), Harvey and Chatterjee (1974), Lenin (1963), Luxemburg (1951), Marx (1967a, 1967b, 1968, 1970, 1971, 1972, 1973), Marx and Engels (1955), and Smith (1984). This section is based on Harvey (1975a).

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118 Place attachment Luxemburg, R., 1951, The Accumulation of Capital, London, England: Routledge & Kegan Paul. Manzo, L.C., 2003, “Beyond House and Haven: Toward a Revisioning of Emotional Relationships with Places,” Journal of Environmental Psychology, 23, 47–61. Manzo, L.C., 2005, “For Better or Worse: Exploring Multiple Dimensions of Place Meaning,” Journal of Environmental Psychology, 25, 67–86. Markus, H., 1977, “Self-Schemata and Processing Information about the Self,” Journal of Personality and Social Psychology, 35, 63–78. Marx, K., 1967a, Capital, three volumes, New York, U.S.A.: International Publishers. Marx, K., 1967b, 1968, and 1972, Theories of Surplus Value, three parts, Moscow, Russia: Progress Publishers. Marx, K., 1970, A Contribution to the Critique of Political Economy, New York, U.S.A.: International Publishers. Marx, K., 1971, On Colonialism, New York, U.S.A.: International Publishers. Marx, K., 1973, Grundrisse, Harmondsworth, Middlesex: Penguin Books. Marx, K. and Engels, F., 1955, Selected Correspondence, Moscow, Russia: Progress Publishers. Massey, D., 2004, “Geographies of Responsibility,” Geografiska Annaler, 86B, 5–18. Mazumdar, S. and Mazumdar, S., 2004, “Religion and Place Attachment: A Study of Sacred Places,” Journal of Environmental Psychology, 24, 385–397. McAndrew, F.T., 1998, “The Measurement of ‘Rootedness’ and the Prediction of Attachment to Home-Towns in College Students,” Journal of Environmental Psychology, 18, 409–417. McMillan, D.W. and Chavis, D.M., 1986, “Sense of Community: A Definition and Theory,” Journal of Community Psychology, 14, 6–23. Mesch, G.S. and Manor, O., 1998, “Social Ties, Environmental Perception, and Local Attachment,” Environment and Behavior, 30, 227–245. Michelson, W., 1976, Man and His Urban Environment: A Sociological Approach, with Revisions, Reading, Massachusetts, U.S.A.: Addison-Wesley. Milligan, M.J., 1998, “Interactional Past and Potential: The Social Construction of Place Attachment,” Symbolic Interaction, 21, 1–33. Mitchell, D., 2003, The Right to the City: Social Justice and the Right for Public Space, New York, U.S.A.: Guilford Press. Mitchell, M.Y., Force, J.E., Carroll, M.S., and McLaughlin, W.J., 1993, “Forest Places of the Heart: Incorporating Special Spaces into Public Management,” Journal of Forestry, 91:4, 32–37. Nasar, J.L. and Julian, D.A., 1995, “The Psychological Sense of Community in the Neighborhood,” Journal of the American Planning Association, 61, 178–184. Norberg-Schultz, C., 1979, Genius Loci: Towards a Phenomenology of Architecture, New York, U.S.A.: Rizzoli. Patterson, Michael E. and Williams, Daniel R., 2005, “Maintaining Research Traditions on Place: Diversity of Thought and Scientific Progress,” Journal of Environmental Psychology, 25, 361–380. Peet, R., 1999, Modern Geographical Thought, Malden, Massachusetts, U.S.A.: Blackwell. Perkins, D.D. and Long, D.A., 2002, “Neighborhood Sense of Community and Social Capital: A Multi-Level Analysis,” in Fisher, A., Sonn, C., and Bishop, B., (eds.), Psychological Sense of Community: Research, Applications, and Implications, New York, U.S.A.: Plenum, pp. 291–318.

Place attachment 119 Petrzelka, P., 2004, “The New Landform’s Here! The New Landform’s Here! We’re Somebody Now! The Role of Discursive Practices on Place Identity,” Rural Sociology, 69:3, 386–404. Pretty, G.H., Chipuer, H.M., and Bramston, P., 2003, “Sense of Place amongst Adolescents and Adults in Two Rural Australian Towns: The Discriminating Features of Place Attachment, Sense of Community and Place Dependence in Relation to Place Identity,” Journal of Environmental Psychology, 23, 273–287. Proshansky, H.M., 1978, “The City and Self-Identity,” Environment and Behavior, 10, 147–169. Proshansky, H.M. and Fabian, A.K., 1987, “The Development of Place Identity in the Child,” in Weinstein, C.S. and David, T.G., (eds.), Spaces for Children, New York, U.S.A.: Plenum, pp. 21–40. Relph, E., 1970, “An Inquiry into the Relations between Phenomenology and Geography,” Canadian Geographer, 14, 193–201. Relph, E., 1976, Place and Placelessness, London, England: Pion Ltd. Relph, E., 1997, “Sense of Place,” in Hanson, S. (ed.), Ten Geographic Ideas that Changed the World, New Brunswick, New Jersey, U.S.A.: Rutgers University Press. Ridington, R., 1982, “When Poison Gas Comes Down Like a Fog,” Human Organization, 41, 36–42. Riemer, J.W., 2004, “Job Relocation, Sources of Stress, and Sense of Home,” Community, Work, and Family, 2, 205–217. Riger, S. and Lavrakas, P.J., 1981, “Community Ties: Patterns of Attachment and Social Interaction in Urban Neighborhoods,” American Journal of Community Psychology, 9, 55–66. Riley, R.B., 1992, “Attachment to the Ordinary Landscape,” in Altman, I. and Low, S. M., (eds.), Place Attachment, New York, U.S.A.: Plenum, pp. 13–35. Rubenstein, R.L. and Parmelee, P.A., 1992, “Attachment to Place and the Representation of the Life Course by the Elderly,” in Altman, I. and Low, S.M., (eds.), Place Attachment, New York, U.S.A.: Plenum, pp. 139–163. Rudzitis, G., 1993, “Nonmetropolitan Geography: Migration, Sense of Place, and the American West,” Urban Geography, 14:6, 574–585. Sack, R.D., 1980, Conceptions of Space in Social Thought, London, England: Macmillan. Salamon, S., 1980, “Ethnic Differences in Farm Family Land Transfers,” Rural Sociology, 45, 290–308. Salamon, S., 1984, “Ethnic Origin as Explanation for Local Land Ownership Patterns,” Research in Rural Sociology and Development, 1, 161–186. Salamon, S., 1985a, “Ethnic Communities and the Structure of Agriculture,” Rural Sociology, 50, 323–340. Salamon, S., 1985b, “An Anthropological View of Land Transfers,” in Moyer, D. and Wunderlich, G., (eds.), Transfer of Land Rights, Washington, D.C., U.S.A.: U.S. Department of Agriculture, pp. 123–144. Salamon, S. and O’Reilly, S.M., 1979, “Family Land and Development Cycles among Illinois Farms,” Rural Sociology, 44, 525–542. Sanders, S., Bowie, S.L., and Bowie, Y.D., 2003, “Lessons Learned on Forced Relocation of Older Adults: The Impact of Hurricane Andrew on Health, Mental Health, and Social Support of Public Housing Residents,” Journal of Gerontological Social Work, 40, 23–35. Scannell, Leila and Gifford, Robert, 2010, “Defining Place Attachment: A Tripartite Organizing Framework,” Journal of Environmental Psychology, 30, 1–10.

120 Place attachment Schroeder, H.W., 2000, “What Makes a Place Special? Interpretation of Written Survey Responses in Natural Resource Planning,” in Bengston, D.N., (ed.), Applications of Computer-Aided Text Analysis in Natural Resources, GTR-NC 211, St. Paul, Minnesota, U.S.A.: USDA Forest Service, North Central Research Station, pp. 7–11. Seamon, D., 1980, “Body-Subject, Time-Space Routines, and Place-Ballets,” in Buttimer, A. and Seamon, D., (eds.), The Human Experience of Space and Place, New York, U.S.A.: St. Martin’s Press, pp. 148–165. Seamon, D., 1982, “The Phenomenological Contribution to Environmental Psychology,” Environmental Psychology, 2, 119–140. Seamon, D., 1987, “Phenomenology and Environment-Behavior Research,” in Zube, E.H. and Moore, G.T., (eds.), Advances in Environment and Behavior Design, Vol. 1., New York, U.S.A.: Plenum Press. Seamon, D., 1993, Dwelling, Seeing, and Designing: Toward a Phenomenological Ecology, New York, U.S.A.: State University of New York Press. Seamon, D., 2000, “A Way of Seeing People and Place: Phenomenology in Environment-Behavior Research,” in Wapner, S., Demick, J., Yamamoto, T., and Minami, H., (eds.), Theoretical Perspective in Environment-Behavior Research: Underlying Assumptions, Research Problems, and Methodologies, New York, U.S.A.: Kluwer Academic/ Plenum Publishers, pp. 157–178. Seamon, D., 2002, “A World More Robust and Kind: The First Volume in Christopher Alexander’s Nature of Order,” Environmental and Architectural Phenomenology Newsletter, 13, 4–8. Shamai, S., 1991, “Sense of Place: An Empirical Measurement,” Geoforum, 22, 347–358. Shields, R., 1991, Places on the Margin: Alternative Geographies of Modernity, New York, U.S.A.: Routledge. Shumaker, R.S. and Taylor, R.B., 1983, “Toward a Clarification of People-Place Relationships: A Model of Attachment to Place,” in Feimer, N.R. and Geller, E.S., (eds.), Environmental Psychology: Directions and Perspectives, New York, U.S.A.: Praeger, pp. 219–251. Smith, N., 1984, Uneven Development: Nature, Capital, and the Production of Space, Oxford, England: Basil Blackwell. Soja, E., 1989, Postmodern Geographies: The Reassertion of Space in Critical Social Theory, London, England: Verso. Soja, E., 1996, Thirdspace: Journeys to Los Angeles and Other Real-and-Imagined Places, Cambridge, England: Blackwell. Stedman, R.C., 1999, “Sense of Place as an Indicator of Community Sustainability,” Forestry Chronicle, 75:5, 765–770. Stedman, R.C., 2002, “Toward a Social Psychology of Place: Predicting Behavior from Place-Based Cognitions, Attitude, and Identity,” Environment and Behavior, 34:5, 561–581. Stedman, R.C., 2003a, “Is It Really Just a Social Construction?: The Contribution of the Physical Environment to Sense of Place,” Society and Natural Resources, 16, 671–685. Stedman, R.C., 2003b, “Sense of Place and Forest Science: Toward a Program of Quantitative Research,” Forest Science, 49:6, 822–829. Steger, M.B., 2002, Globalism: The New Market Ideology, New York, U.S.A.: Rowan & Littlefield. Stoffle, R.W., Halmo, D.B., Olmsted, J.E., and Evans, M.J., 1990, Native American Cultural Resource· Studies at Yucca Mountain, Nevada, Ann Arbor, Michigan, U.S.A.: University of Michigan, Institute for Social Research.

Place attachment 121 Stoffle, R.W., Traugott, M.W., Stone, J.V., McIntyre, P.D., Jensen, F.V., and Davidson, C.C., 1991, “Risk Perception Mapping: Using Ethnography to Define the Locally Affected Population for a Low-Level Radioactive Waste Storage Facility in Michigan,” American Anthropologist, 93, 611–635. Stokols, D. and Shumaker, S.A., 1981, “People in Places: A Transactional View of Settings,” in Harvey, J., (ed.), Cognition, Social Behavior, and the Environment, Hillsdale, New Jersey, U.S.A.: Erlbaum, pp. 441–488. Stokowski, P.A., 2002, “Languages of Place and Discourses of Power: Constructing New Senses of Place,” Journal of Leisure Research, 34, 368–382. Tuan, Y.F., 1974, Topophilia: A Study of Environmental Perception, Attitudes, and Values, New York, U.S.A.: Columbia University Press. Tuan, Y.F., 1975, “Place: An Experiential Perspective,” Geographical Review, 65, 151–165. Tuan, Y.F., 1977, Space and Place: The Perspective of Experience, Minnesota, U.S.A.: University of Minnesota Press. Tuan, Y.F., 1991, “Language and the Making of Place: A Narrative-Descriptive Approach,” Annals of the Association of American Geographers, 81:4, 684–696. Twigger-Ross, C.L. and Uzzell, D.L., 1996, “Place and Identity Processes,” Journal of Environmental Psychology, 16, 205–220. Uzzell, D., Pol, E., and Badenas, D., 2002, “Place Identification, Social Cohesion, and Environmental Sustainability,” Environment and Behavior, 34, 26–53. Virden, R.J. and Walker, G.J., 1999, “Ethnic/Racial and Gender Variations among Meanings Given to, and Preferences for, the Natural Environment,” Leisure Sciences, 21, 219–239. Vorkinn, M. and Riese, H., 2001, “Environmental Concern in a Local Context: The Significance of Place Attachment,” Environment and Behavior, 33:2, 249–263. Whittemore, H., 1992, “A Man Who Would Save the World,” Parade: The Sunday Newspaper Magazine, April 12, 4–7. Williams, D.R., 2000, “Personal and Social Meanings of Wilderness: Constructing and Contesting Place in a Global Village,” in Watson, A.E. and Applet, G., (eds.), Personal, Societal, and Ecological Values of Wilderness: Sixth World Wilderness Congress Proceedings on Research, Management, and Allocation, Volume II, Ogden, Utah, U.S.A.: U. S. Forest Service, Rocky Mountain Research Station, pp. 77–82.. Williams, D.R., 2002, “Leisure Identities, Globalization, and the Politics of Place,” Journal of Leisure Research, 34:4, 351–367. Williams, D.R., and Van Patten, S., 1998, “Back to the Future? Tourism, Place, and Sustainability,” in Anderson, L. and Blom, T., (eds.), Sustainability and Development: On the Future of Small Society in a Dynamic of Economy, Karlstad, Sweden: University of Karlstad, pp. 359–369. Williams, D.R., Patterson, M.E., Roggenbuck, J.W., and Watson, A.E., 1992, “Beyond the Commodity Metaphor: Examining Emotional and Symbolic Attachment to Place,” Leisure Sciences, 14, 29–46. Woldoff, R.A., 2002, “The Effects of Local Stressors on Neighborhood Attachment,” Social Forces, 81, 87–116. Young, M. and Willmott, P., 1962, Family and Kinship in East London, London, England: Pelican.

3

The equity home bias puzzle A place-attachment explanation

This chapter views place attachment as a contributing factor to the equity home bias. It provides overviews of the literature on 22 different topics in which variations of home bias are present, and notes that equity home bias is only one of them. The common contributing factor to all 22 home bias topics – including the equity home bias – can be seen to be place attachment. The 22 different topics, which are discussed in the rest of this chapter, are as follows: (1) equity investment, (2) bond investment, (3) equity analysts, (4) loan market, (5) saving-investment, (6) foreign stock listing, (7) currency, (8) international business, (9) international trade, (10) international marketing, (11) mergers and acquisitions, (12) economic nationalism, (13) corporate governance, (14) accounting standards, (15) government procurement, (16) academic research citations, (17) patent citations, (18) entrepreneurship, (19) entrepreneur location choice, (20) forum selection in law, (21) real estate, and (22) sport competition.

3.1 Equity investment Modern portfolio theory predicts that investors would hold a diversified portfolio of equities across the world if capital is fully mobile across borders. This prediction contradicts the observed data on portfolio holdings and is wellknown in international finance as the home equity puzzle or equity home bias – the empirical finding that people overinvest in domestic stocks relative to the optimal investment portfolio implied by the modern portfolio theory.1 Financial globalization, which has emerged as a result of the liberalization of capital account, growth of electronic trading, speed of information exchange, and reduction of transaction costs, has led to a significant increase in the volume of international financial asset trade. However, home bias in equities is still prevalent in most countries, though slowly falling, and tends to be higher in emerging markets. For instance, in 2007, U.S. investors held more than 80% of domestic equities, which is much higher than the proportion of U.S. equities to the world market portfolio. Since the seminal paper of French and Poterba (1991), the home bias in equities has fascinated both financial economists and international macroeconomists, such

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that Obstfeld and Rogoff (2001) officially recognized home bias as one of the six major puzzles in international macroeconomics. Various explanations have been offered in the literature that discuss the underlying factors leading to this very robust portfolio fact. Such explanations contribute to the justification of parts of the home equity bias, and include: (1) hedging home risks; (2) barriers to foreign investments; (3) information asymmetries; (4) risk aversion instability; (5) corporate governance and transparency; and (6) behavioral factors. The consensus is that none of the explanations can account for the full extent of the bias by itself, thus the home bias should be explained by a combination of rational and behavioral factors. Among these explanations, information asymmetries and behavioral factors are most preferred. Huberman (2001) explains equity home bias based on the argument that people prefer to invest in the familiar. People feel comfortable investing their money in the stocks of a company that is visible to them. Huberman (2001) shows that shareholders of a Regional Bell Operating Company (RBOC) typically live in the region which it serves, and the customers of an RBOC typically hold the stocks of that RBOC rather than the stocks of other RBOCs. Feldstein and Horioka (1980) document high positive correlation between a country’s savings rate and investment rate, and conclude that, typically, capital flows to familiar domestic investment opportunities, rather than to the most profitable ones. Grinblatt and Keloharju (2001) note that familiarity has many facets, and document that a company’s language, culture, and distance from the investor are three important familiarity attributes that influence an investor’s preference for investment in the stocks of certain companies. Coval and Moskowitz (1999) report that a typical U.S. money manager’s equity portfolio consists of stocks of companies that are located 100 miles closer to the money manager’s office than an average U.S. company. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.2 Bond investment Papers such as Tesar and Werner (1995) show that home bias appears in bonds as well as equity, further deepening the equity home bias puzzle. Burger and Warnock (2003) find that foreign bonds comprised about 6% of U.S. investors’ bond portfolios in 1997 and 4% in 2001. Corroborating this evidence further, Fidora, Fratzscher, and Thimann (2007) show that there is substantial home bias in bond holdings for several advanced countries: Japan, the United Kingdom, Germany, Italy, and France.2 Fidora et al. (2007) focus on the role of real exchange rate volatility as a key determinant of international portfolio allocation decisions. An interesting feature of their study is that it does not focus solely on stock holdings, but provides a link between the home bias in the stock and in the bond markets. Their model implies that real exchange rate volatility induces a higher home bias for assets

124 A place-attachment explanation with lower local currency return volatility, that is, a higher home bias for bonds than for equities. Fidora et al. (2007) find that for 40 home countries and up to 120 destination countries, real exchange rate volatility explains 20% to 30% of the cross-country variation in equity home biases and even a larger part of the variation in bond home biases. Berriel and Bhattarai (2013) explain why both international nominal bonds and equity portfolios are biased domestically. They solve for equity and nominal bonds portfolios in a standard two-country general equilibrium model in the presence of government spending shocks and nominal shocks (shocks to the price level). A calibrated version of their model predicts asset holdings that quantitatively match the data. Petersen and Rajan (2002) study the effect of distance on lending relationships. They note that being in close proximity to a firm means that investors do have access to more, or more accurate, information about the firm. Aviat and Coeurdacier (2007) revisit the impact of distance on cross-border equity holdings and bank loans. They find that the impact of distance is drastically reduced once it is controlled for bilateral goods trade: Countries’ portfolios are strongly biased toward trading partners (see also Lane and Milesi-Ferretti 2008). Using instrumental variables, they show that the causality goes essentially one way: reducing barriers to trade in goods enhances crossborder asset holdings. However, they cannot reject the role of goods trade in fostering information flows across borders. In the context of syndicated loan markets, Giannetti and Yafeh (2012) identify two channels through which cultural distance may influence individual portfolio decisions – information asymmetries and transaction costs. First, they argue that cultural differences exacerbate the intensity of information asymmetries and the resulting agency problems. Hence, cultural distance should enhance the perceived riskiness of foreign bonds. Second, Giannetti and Yafeh (2012) state that cultural distance may also reflect institutional differences related to legal systems and contracting terms that increase the cost of information gathering and, thus, further reduce the attractiveness of foreign investment. Finally, investors perceive host countries that are culturally similar to their home countries as more familiar (Grinblatt and Keloharju 2001; Huberman 2001). Pradkhan (2016) examines whether the documented importance of culture and patriotism for the explanation of equity home bias can be extended to home bias in bond markets, and, thus, indirectly explores whether patriotism and cultural characteristics of the home country are asset-invariant home bias drivers that determine allocations to both debt and equity securities. From a variety of cultural dimensions identified by Hofstede, Hofstede, and Minkov (2010) and House et al. (2004), Pradkhan (2016) chooses uncertainty avoidance and individualism for two reasons. First, these cultural dimensions reflect behavioral aspects that are relevant to portfolio allocation decisions. Second, their definition and measurement are consistent across different studies. Overall, Pradkhan (2016) explores whether patriotism, cultural distance, individualism,

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and uncertainty avoidance contribute to the explanation of the home bias phenomenon in bond markets. Pradkhan’s (2016) empirical analysis confirms that patriotism and uncertainty avoidance of the home country play an important role in the explanation of the home bias in bonds. Patriotism fosters overinvestment in domestic debt securities and increases underinvestment in foreign debt markets. Societies characterized by higher uncertainty avoidance display a lower preference for foreign debt securities. Pradkhan’s (2016) results are robust to various regression specifications. Pradkhan (2016) notes that, in general, contrary to a vast literature on equity home bias, studies on home bias in bonds are rather scarce, and none of them incorporates either cultural aspects or patriotism in the empirical examination of domestic and foreign bond bias levels. Most existing studies on home bias in bonds focus on neoclassical factors such as financial liberalization, real exchange rate risk, investor protection, economic and financial market development, as well as traditional familiarity proxies such as common border, common language, and geographic distance (De Moor and Vanpee 2013; Ferreira and Miguel 2011; Fidora et al. 2007; Solnik and Zuo 2017). Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.3 Equity analysts Malloy (2005) provides evidence that geographically proximate analysts are more accurate than other analysts. Stock returns immediately surrounding forecast revisions suggest that local analysts impact prices more than other analysts. These effects are strongest for firms located in small cities and remote areas. Collectively these results suggest that geographically proximate analysts possess an information advantage over other analysts, and that this advantage translates into better performance. Malloy (2005) notes that arguments supporting a link between proximity and information flow are presented in Coval and Moskowitz (2001), who analyze the role of geography in the context of mutual fund managers. They maintain that geographic proximity is inversely related to the cost of information acquisition. Geographic proximity also provides access to private information. This is because, according to Coval and Moskowitz (2001), investors located near a firm can visit the firm’s operations, talk to suppliers and employees, as well as assess the local market conditions in which the firm operates. Similarly, Malloy (2005) argues that the ability of local analysts to make house calls – rather than conference calls – during which time they can meet CEOs face to face and survey the firm’s operations directly, provides them with an opportunity to obtain valuable private information. Following this logic, geographic proximity is a sensible proxy for the quality of analysts’ information. Malloy (2005) further notes that, on a more basic level, the advantage of focusing on equity analysts is that this industry offers an ideal testing ground for a number of theories of economic behavior. Since analyst data are available in

126 A place-attachment explanation large quantities and in relatively standardized formats, this industry is one of the few areas that allows precise estimation of the effects of asymmetric information, agency costs, herding, etc., for an important segment of the financial community. Malloy (2005) uses this testing ground to evaluate the idea that geographic proximity facilitates information flow. Malloy’s (2005) paper contributes to the growing literature on the importance of geography in economics. Coval and Moskowitz (1999), Huberman (2001), and Zhu (2002), report strong preferences for geographically local equities among investors. Hong, Kubik, and Stein (2005) link geographic proximity and mutual fund managers as in Coval and Moskowitz (2001), but instead focus on the information that investors who are close together can pass on to one another; they document a word-of-mouth effect, whereby local mutual fund managers are more likely to hold a particular stock if other managers from different fund families in the same city are holding that same stock. Similarly, Grinblatt and Keloharju (2001) report that investors are more likely to buy, hold, and sell stocks of Finnish firms that are located close to the investor, while Portes and Rey (2005) find a strong geographic component in cross-border equity flows. Berger et al. (2005) and Petersen and Rajan (2002) also explore the concept of physical distance, but do so in the context of commercial banks’ lending to small companies. Malloy (2005) states that only a few papers explore geography in the context of equity analysis. In addition, all of the existing studies focus on cross-border effects rather than within-country effects. The international evidence appears to be mixed. For example, Chang (2002) explores the Taiwanese market and finds that expatriate analysts located outside the country (but whose firms have a local research group) not only outperform otherwise similar foreign analysts, but also outperform local analysts. Similarly, Bacmann and Bolliger (2001) find that foreign financial analysts outperform home country analysts in Latin American emerging markets. On the other hand, Bolliger (2004) reports an accuracy advantage for home country analysts at small and medium-size brokerage houses in Europe, and Orpurt (2002) finds that home country analysts covering Germanheadquartered firms forecast earnings better in the short run than foreign analysts. However, none of these papers tests a pure distance effect, since borders introduce a host of other issues. As such, by focusing solely on U.S. equity analysts covering domestic firms, Malloy’s (2005) paper is the first to isolate the effect of physical distance on the accuracy and investment value of analysts’ forecasts and recommendations. Malloy’s (2005) paper investigates the effect of distance on the accuracy and investment value of equity analysts’ forecasts and recommendations. Using a large panel of analyst data from 1994 to 2001, Malloy (2005) provides evidence that geographically proximate analysts outperform their distant counterparts. Specifically, local analysts are significantly more accurate than other analysts. Malloy (2005) finds this effect to be strongest in small firms, in firms located outside of the most populated cities, and in firms located in remote areas. Abnormal returns surrounding large analysts’ forecast revisions suggest that local analysts also impact stock prices more than other analysts.

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Malloy (2005) argues that these findings are consistent with the hypothesis that geographically proximate analysts possess an information advantage over other analysts. As an information story would suggest, local analysts appear to have a decided advantage in covering small stocks and stocks located in remote areas, where the access to private information is likely to be strongest and competition for that information the weakest. By contrast, Malloy (2005) finds little support for the notion that the link between geography and performance is a natural byproduct of the endogenous coverage decisions made by analysts. For example, local analysts do not outperform other analysts simply as a result of covering fewer stocks or through increased specialization. Malloy (2005) presents some evidence that local investor demand or visibility may be linked to local abnormal performance, perhaps through increased analyst attention or effort, but these results are based on a small subset of stocks for which advertising expense is nonzero. Pursiainen (2018) studies the link between equity analysts’ cultural biases and their stock recommendations. Pursiainen (2018) identifies analysts’ countries of origin based on their surnames, and uses a Eurobarometer-based measure of bilateral trust between European nations to measure cultural bias. Pursiainen (2018) finds that a higher level of trust by the analyst’s country of origin toward the company’s headquarter’s country is associated with significantly more positive stock recommendations. This effect is robust to controlling for time-varying company- and analyst-specific factors. Furthermore, this effect is stronger for stocks with higher forecast uncertainty, and is weaker for analysts working at larger brokers. In contrast, higher trust is associated with more accurate and less optimistic earnings estimates. Pursiainen (2018) notes that there is an increasing recognition in the economic literature that culture and cultural background matter: They may also represent a source of bias in decision-making. Trust is an essential component of virtually every commercial transaction. A number of studies suggest a positive relationship between trust and economic growth (e.g., Knack and Keefer 1997; Temple and Johnson 1998). Guiso, Sapienza, and Zingales (2004a) find that trust-enhancing social capital is an important determinant of financial development, while Guiso, Sapienza, and Zingales (2008) show the importance of trust for stock market participation. La Porta et al. (1997a) show that trust is essential for the existence and operation of large organizations. Bloom, Sadun, and Van Reenen (2012) find that trust increases aggregate productivity by affecting the organization of firms and allowing them to decentralize their operations. Guiso et al. (2009) show that higher bilateral trust between two countries leads to more trade, more portfolio investment, and more direct investment between them. Furthermore, they show that bilateral trust is affected not only by the characteristics of the country being trusted, but also by cultural aspects of the match between trusting country and trusted country, such as their history of conflicts and their religious, genetic, and somatic similarities. Similarly, Bottazzi, Da Rin, and Hellmann (2016) study the role of bilateral trust in venture capital investments and find that trust between nations positively

128 A place-attachment explanation predicts venture capital firms’ investment decisions, but that it has a negative correlation with successful exits; that is, it is associated with worse performance of such investments. Fisman, Paravisini, and Vig (2017) find evidence that cultural proximity between lenders and borrowers increases the quantity of credit and reduces default, using data from an Indian bank. Pursiainen (2018) further notes that cultural biases have been shown to affect individuals’ investment decisions. For example, Grinblatt and Keloharju (2001) show that investors are more likely to hold, buy, and sell the stocks of Finnish firms that are located close to the investor, that communicate in the investor’s native tongue, and that have chief executives of the same cultural background. Morse and Shive (2011) find evidence that investors in more patriotic countries have a greater home bias in their equity selection. Kumar, Niessen-Ruenzi, and Spalt (2015) find that name-induced stereotypes affect the investment choices of U.S. mutual fund investors. Managers with foreign-sounding names have lower fund inflows, and this effect is stronger among funds with investor clienteles more likely to be suspicious of foreigners. Pursiainen (2018) states that there is limited existing literature on the impact of culture on equity research. Jia et al. (2017) utilize segmented dual-class shares of Chinese firms to document differential reactions of local and foreign investors to analyst recommendations, suggesting that social connections between analysts and investors affect investor reactions to analyst recommendations. Du et al. (2017) study the effect of cultural background on the processing of information, and find that Chinese analysts issue more accurate forecasts on Chinese firms than non-Chinese analysts. Jannati et al. (2016) find evidence of in-group bias in sellside analyst forecasts and recommendations, manifested in male analysts having lower assessments of firms headed by female CEOs than of firms headed by male CEOs. Their results are similar if in-groups are defined based on domestic vs. foreign nationality or political attitudes. These findings suggest that personal biases related to nationality can affect stock recommendations. Pursiainen (2018) observes that sell-side equity analysts are an integral part of well-functioning capital markets: They perform fundamental analysis of companies and industries, thereby helping investors to make informed decisions and the market to allocate capital efficiently. A substantial body of literature documents the importance of analysts on capital markets.3 Obviously, the usefulness of sell-side analyst recommendations and estimates depends on the extent to which they are neutral, unbiased, and contain valuable information. Hence, another substantial strand of literature focuses on the biases arising from potential conflicts of interest, often related either to the sell-side analyst’s employer seeking other business from the covered companies or to the analyst’s personal career concerns.4 Pursiainen (2018) points out that sell-side analyst recommendations provide an ideal setting to study cultural biases, as the underlying asset is the same for all analysts providing recommendations for it. That also means that the investment is as good or bad for anybody, regardless of which of the countries they are from. If a French analyst trusts the British less than a Swedish analyst, and hence

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assigns British companies more negative recommendations, there is no rational explanation allowing for both analysts to be “right.” The systematic difference in recommendations must relate to systematic differences in information or, more plausibly, biases in interpreting that information. Pursiainen’s (2018) results show that higher bilateral trust by the analyst’s country of origin toward the company’s headquarter’s country is associated with significantly more positive stock recommendations. This result is consistent across different model specifications, and robust to controlling for firm-year joint fixed effects, analyst-year joint fixed effects, and broker fixed effects. Pursiainen (2018) also controls for a number of relative variables between the analyst’s country of origin and the company’s headquarters’ country, including geographic distance, indicators of same country and shared borders, level of information (as proxied by newspaper coverage and Google search volume), as well as language similarity. Importantly for interpreting the results, the combination of fixed effects that Pursiainen (2018) includes captures both the average, “objective” trustworthiness of the company country and the average tendency of the citizens of the analyst’s country of origin to trust. Therefore, the remaining variation in trust represents a residual not captured by these average affects, allowing an interpretation as a cultural bias. Pursiainen (2018) also states that this bias effect of generalized trust is economically significant. For example, the estimated coefficients from Pursiainen’s (2018) regression analysis suggest that the differences in the level of bilateral trust alone would result in a Swedish analyst assigning a British company an expected recommendation that is 0.16 units (coded from one to five) more positive than what a French analyst would recommend. Similarly, a Swedish analyst would be an estimated 8.2 percentage points more likely to assign a buy-recommendation and 5.4 percentage points less likely to assign a sell-recommendation to a British company than a French analyst. Without any controls, in Pursiainen’s (2018) data, the average recommendation for British companies by Swedish analysts is, in fact, 0.057 units more positive, and Swedish analysts are 6.7 percentage points more likely to assign a buy recommendation and 6.1 percentage points less likely a sell recommendation to British companies than French analysts. Pursiainen (2018) also finds that, in contrast to recommendations, higher trust is not associated with an upward bias in earnings estimates. On the contrary, higher trust is associated with less optimistic and more accurate earnings and sales growth estimates. This finding would be consistent with higher trust facilitating better communication with management and hence resulting with better-informed forecasts. Pursiainen (2018) furthermore finds that the positive relationship between trust and analyst recommendations is stronger for stocks with higher forecast uncertainty, as measured by the standard deviation of earnings per share (EPS) estimates. This finding is intuitive and suggests that cultural biases have a larger effect when objective estimates are more uncertain. Finally, Pursiainen (2018) finds that the positive relationship between trust and analyst recommendations is weaker for analysts working at larger brokers. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

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3.4 Loan market Carey and Nini (2007) offer evidence that interest rate spreads on syndicated loans to corporate borrowers are economically significantly smaller in Europe than in the United States, other things being equal. Differences in borrower, loan, and lender characteristics do not appear to explain this phenomenon. Borrowers overwhelmingly issue in their natural home market and bank portfolios display home bias. This may explain why pricing discrepancies are not competed away, though their causes remain a puzzle. Thus, important determinants of loan origination market outcomes remain to be identified, home appears to be material for pricing, and corporate financing costs differ across Europe and the United States.5 More specifically, Carey and Nini (2007) offer evidence that prices of syndicated corporate loans differ between the European and U.S. markets, with interest rate spreads smaller in Europe by about 30 basis points on average over the past decade, after controlling for risk and other factors. The differences are economically and statistically significant. Levels of differences are larger for riskier borrowers, but spreads in the European market are roughly 20% less than for comparable loans in the United States across the risk spectrum. Carey and Nini (2007) cannot reject the hypothesis that price differences are as large today as they were a decade ago. Carey and Nini (2007) control for a host of factors known (or thought) to affect corporate debt decisions and pricing. Although many controls are correlated with levels of spreads, they have little effect on the price difference across markets. Such a material difference in pricing can persist only if lenders and borrowers fail to compete it away. Though Carey and Nini (2007) focus on pricing, they also provide some evidence about the location of borrowers’ and lenders’ activity. The data show that borrowers stay home when they can, and that they tend to issue in Europe when they must issue abroad. Specifically, borrowers domiciled in one of the major markets (Europe, United States, and Asia) almost always issue in that market, whereas borrowers domiciled elsewhere usually issue in Europe. Lenders cross borders more frequently, but still display significant home bias. About one-quarter of the volume of lending in the United States and European markets is provided by lenders headquartered elsewhere, but lenders domiciled in a market region still participate in loans made in that market significantly more frequently than the share of such loans in the world syndicated loan market. This market segmentation likely prevents competition from causing prices to converge in the two markets. A natural first hypothesis about pricing differences is that loan or borrower characteristics differ across markets. Carey and Nini’s (2007) empirical tests control for a wide variety of factors and mechanisms suggested in the corporate debt and financial intermediation literatures, including potential cross-market differences in credit risk; non-price loan terms (e.g., maturity); asymmetric information or moral hazard (Berlin and Mester 1992; Diamond 1984); legal regime (La Porta et al. 1997b); multiproduct package pricing practices;

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regulation (McCauley and Seth 1992); currency in which the loan is denominated; and others. Carey and Nini (2007) find that many of these considerations are material to loan pricing, but the difference in average loan spreads across markets persists, suggesting that the market effect is not due to well-understood differences in the composition of borrower or loan characteristics. Moreover, the pricing difference is not driven by borrowers from a subset of European countries or by lenders from a subset of countries, nor does it appear to be driven by state-owned banks or differences in regulation across countries. A natural second hypothesis is that unexplained price differences are due to errors in Carey and Nini’s (2007) data or to weakness of the proxy variables that they use in testing hypotheses. Price differences do not appear to be a data problem. The result is remarkably robust, and Carey and Nini (2007) have cross-checked key variables with alternative sources. Carey and Nini (2007) use multiple proxies for credit risk, which is the most important control variable. More generally, they use conventional variables from the literature on corporate debt and are left with an economically important puzzle. Carey and Nini (2007) cannot reject the hypothesis that their finding is evidence of market inefficiency in the sense of myopic behavior by market participants. However, the size of the pricing difference and the sophistication of syndicated loan market participants lead Carey and Nini (2007) to discount this possibility. The most active lenders are large banks headquartered in a variety of nations, each with significant international operations. Many lend in both the United States and Europe. Similarly, borrowers are large corporations, many with international operations. It is difficult to believe that such market participants would fail to cross oceans in pursuit of lower financing costs due to myopia. Degryse and Ongena (2005) study the effect on loan conditions of geographic distance between firms, the lending bank, and all other banks in the vicinity. For their study, they employ detailed contract information from more than 15,000 bank loans to small firms comprising the entire loan portfolio of a large Belgian bank. Degryse and Ongena (2005) report the first comprehensive evidence on the occurrence of spatial price discrimination in bank lending. Loan rates decrease with the distance between the firm and the lending bank, and increase with the distance between the firm and competing banks. Transportation costs cause the spatial price discrimination which they observe. More specifically, Degryse and Ongena (2005) study the effect of geographic distance on bank loan rates, taking into account the distance between commercial borrowers and their bank branch as well as the distance between commercial borrowers and other competing banks, while controlling for relevant relationship, loan, bank branch, borrower, and regional characteristics. For their study, they employ a unique data set containing detailed loan contract information, including firm and lender identity and location, from more than 15,000 bank loans to (predominantly) small firms. The bank studied by Degryse and Ongena (2005) operates across the nation and across industries. Most firms in its portfolio are single-person businesses, and many firms obtain only one loan from the bank. Hence, even though

132 A place-attachment explanation distances are typically rather small in Belgium, transportation costs may be important on the margin for the small borrowers in the data set. In addition, formalized interviews with bank managers indicate that loan officers located in the bank’s branches enjoyed substantial autonomy when granting and pricing small business loans. The officers’ own assessment of the development of the relationship with the firm, the skills and reputation of the firm’s management, and the quality of the firm’s business vision (i.e., “soft” information in Stein 2002) played key roles in the lending decision. Though loan officers were required to “harden” their assessment internally by supplying key statistics and other relevant written information, much local discretion remained. In line with the predictions emanating from the theory that models spatial price discrimination, Degryse and Ongena (2005) find that loan rates decrease with the distance between the firm and its lending bank, and increase with the distance between the firm and competing lenders. Degryse and Ongena (2005) identify banking competition and pricing strategies in their analysis by including both the number of bank branches (or, alternatively, branch concentration) and the distance between the borrower and competing bank branches in the vicinity. They observe that increasing distance between the borrower and alternative lenders significantly relaxes price competition and results in substantially higher borrowing costs for the firm. From a variety of exercises, they infer that transportation costs, not informational asymmetries, are probably the main basis for the spatial price discrimination which they observe. Mian (2006) uses a panel of 80,000 loans over 7 years and shows that greater cultural and geographic distance between a foreign bank’s headquarters and local branches leads it to further avoid lending to “informationally difficult” yet fundamentally sound firms requiring relational contracting. Greater distance also makes them less likely to renegotiate bilaterally, and less successful at recovering defaults. Differences in bank size, legal institutions, risk preferences, or unobserved borrower heterogeneity cannot explain these results. These distance constraints can be large enough to permanently exclude certain sectors of the economy from being financed by foreign banks. Using the loan-level data for the banking sector of Pakistan, Mian (2006) finds that foreign banks systematically shy away from lending to soft-information firms that require relational contracting. Such firms include small firms, firms in smaller cities, firms not affiliated with a major business group, firms seeking first-time loans, and firms seeking long-term relational financing. Moreover, consistent with the notion that foreign banks avoid relational lending, Mian (2006) finds that they are less than half as likely as domestic banks to renegotiate bilaterally in the case of default (they litigate more). Foreign banks are also less than half as successful as domestic banks at recovering defaults. These results are not driven by unobserved borrower characteristics, as they are robust to the inclusion of borrower fixed effects. In other words, even when the same borrower defaults to both foreign and domestic banks, domestic banks are more likely to renegotiate successfully with the borrowers, and therefore enjoy higher recovery rates.

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The results above indicate that while foreign banks are quite willing to give out arm’s length or “transaction loans” based on hard information, they are at a comparative disadvantage when it comes to soft information-based relational loans. One hypothesis to explain the above results is that when foreign banks open a branch or subsidiary in a “distant” economy, they face extra informational and agency costs in making relational loans. Broadly speaking, distance here could reflect a number of factors. For example, it may reflect physical distance between the foreign bank’s headquarters (CEO) and the subsidiary, or it could also reflect cultural distance, intra-bank hierarchical distance due to bank size, or institutional (legal) distance between the foreign bank’s country of origin and its subsidiary. Results indicating the reluctance of foreign banks to lend to soft firms requiring relational contracting could thus reflect the additional costs of such distance constraints. To test if the above theory is credible and, if so, which particular definition of distance is most relevant, Mian (2006) exploits the variation among foreign banks in their “distance travelled.” Mian (2006) finds that geographic, or cultural, distance is an important attribute in explaining the lending, recovery, and renegotiation differences between domestic and foreign banks. In particular, these distance constraints are stronger the more geographically or culturally distant a foreign bank is. Moreover, by exploiting variation among firms in their political connectedness, Mian (2006) shows that the distance constraints are more likely to be driven by informational and agency costs rather than greater enforcement problems for foreign banks. Other potential measures of distance, such as bank size and institutional distance, are not correlated with distance constraints. A concern with the above findings may be that perhaps foreign banks avoid soft information loans not because of any limitations, but rather because of the relatively poor quality of these loans. Domestic banks, on the other hand, may not be as scrupulous because of poor banking supervision and the ensuing preference for risky behavior. However, various firm- and loan-level outcomes show that such concerns are not valid. For example, despite making more soft information loans, domestic banks do not have significantly higher default rates than foreign banks. In fact, taking the interest and recovery rates into account, lending by domestic banks is as profitable as lending by foreign banks. Similarly, firms financed by domestic banks are as productive as firms financed by foreign banks in terms of exports. There is also no evidence of related lending by domestic banks. This further diminishes concerns of moral hazard-driven risky lending by domestic banks. Mian’s (2006) paper connects the literature on financial development with the theory of the firm. Since the work of Coase (1937), an important question in this literature has been to understand how informational and agency distance between the CEO and her employees in distant areas (loan officers in the case of banking) shapes the nature of information acquisition and the types of activities performed within the firm. Existing theoretical work, such as Stein (2002) and Aghion and Tirole (1997), suggests that greater distance between

134 A place-attachment explanation the CEO and her employees could lead to less reliance on soft information by the firm. In a first-direct test of such theories, Liberti (2003) shows that decentralization of decision making enhances the transmission of and reliance on soft information within a bank. The results of Mian’s (2006) paper suggest not only that greater distance decreases the incentives of a bank manager to collect soft information, as in Stein (2002), but also that greater cultural distance may make it more costly for certain institutions to collect and communicate soft information. Thus, Mian’s (2006) paper connects the literature on organizations with the literature on culture. The importance of culture in shaping economic outcomes and institutions has already been highlighted in papers such as Greif (1994), Grinblatt and Keloharju (2001), and Stulz and Williamson (2003). Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.5 Saving-investment Feldstein and Horioka (1980) documented high positive correlation between a country’s savings and its investment rate, arguing that capital flows to domestic investment opportunities, not necessarily to the most profitable. In cross-section regressions for 16 countries within the Organization for Economic Co-operation and Development (OECD), Feldstein and Horioka (1980) failed to reject the null hypothesis of a one-to-one association between saving and investment. They interpreted this as implying zero capital mobility. This conclusion was unpalatable both because most theoretical, open economy models had assumed perfect capital mobility, and because it appeared that financial integration in the industrialized world was high and increasing, particularly since the introduction of floating exchange rates in the early 1970s.6 Economists often use the term puzzle to refer to awkward empirical facts that refuse to comply with their established theoretical frameworks. The Feldstein and Horioka (1980) puzzle is a well-known example. Feldstein and Horioka (1980) argued that, under perfect capital mobility, there is no necessary association between national saving and investment, since saving can seek out the highest returns globally. The implication is that an exogenous increase in investment in any country can be financed by a perfectly elastic supply of global funds. By contrast, zero capital mobility implies a one-to-one relationship between saving and investment, since saving has to be invested domestically. In this case, there is a world of segmented capital markets, in which each country’s interest rate is determined domestically and domestic monetary and fiscal policies are relatively effective. These findings sparked an immense literature on the subject, for numerous reasons. First, they are related to the current account dynamics, which is a central issue in open economy macroeconomics. The relevant models consider the empirically observed saving–investment relation as one of the stylized facts that must be explained. Second, by focusing on the net transfers of real

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resources across borders, this relation can be used for the evaluation of the degree of international capital mobility. This, in turn, determines the ability of a country to smooth its aggregate consumption over time, the efficiency of economic policy, as well as the choice to target either domestic savings or domestic capital formation. However, one of the critiques of the puzzle is that the saving–investment correlation coefficient cannot assess whether capital is internationally mobile. Third, the debate is relevant for policy issues, such as the necessity of the euro, the role of overseas balances, and the impact of taxation on capital and savings. In addition, the majority of academics and policy makers recognize its importance for financial liberalization and, as such, they have called it “the mother of all puzzles.” Over the past 25 years, the globe has experienced a substantial financial market deregulation, a major abolishment of capital controls in virtually all economies, and information and communication technological advances that gave a boost to international financial transactions. The extensive research related to the subject aims at understanding what economists have learned, which parts of the puzzle have been resolved, which parts remain to be addressed, and where future research is heading. However, the majority of the studies show that the puzzle remains robust over time, albeit the correlation between savings and investment displays a gradual decline for both developed and developing countries. The main point that should be kept in mind from the large literature that responds to this puzzle is that in the field of international macroeconomics, temporally robust stylized facts are few and far between. One of the most stable regularities observed in the data is the fact that national saving rates are highly correlated with national investment rates, both in time-series analyses of individual countries and in cross-sections in which each country is treated as a single data point. High saving–investment correlations arise in small economies as well as large economies. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.6 Foreign stock listing Sarkissian and Schill (2004) examine the importance of agent proximity preference in financing decisions rather than investing decisions.7 If proximity is important to investing agents, Sarkissian and Schill (2004) postulate that it also affects financing agents. In the investing literature, Coval and Moskowitz (1999, 2001), Grinblatt and Keloharju (2001), Huberman (2001), and Portes and Rey (2005) find that the cultural proximity of the market and assets, as well as the geographic proximity, has an important influence on investor stockholdings and trading. Sarkissian and Schill (2004) take an approach that parallels the approach taken in the investor home bias literature. That is, they ask whether firms choosing not to list abroad sacrifice traditional cost of capital gains in order to

136 A place-attachment explanation secure listings in more proximate or familiar markets. In an integrated, frictionless world capital market, a firm should have no preference for the markets on which it lists its shares, since this choice has no effect on its pool of investors. However, if markets are not fully integrated, two alternatives can be considered. Under the first alternative, a firm may be able to overcome familiarity concerns and portfolio bias of foreign investors by listing in the foreign market (Ahearne, Griever, and Warnock 2004; Baker, Nofsinger, and Weaver 2002; Lang, Lins, and Miller 2003; Merton 1987). In this case, one should expect firms to prefer listing in markets that provide the greatest diversification or familiarity gains. Under the second alternative, a firm’s overseas listing may have little effect on investor familiarity if it is constrained by the existing pool of familiar investors (Kang and Stulz 1997). In that case, the choice of overseas listing venues will reflect the same bias as that of investor holdings, in particular a bias toward more proximate or familiar markets. In a sense, since firm managers are aware that foreign investors are less willing to invest in equities of lesser-known companies, firms will find it inefficient to list their stocks in the markets where their presence is not supported by sufficient information. Hence, one needs to examine the firm’s trading venue decision empirically, focusing on the firm’s ability to enter nonproximate markets. Sarkissian and Schill (2004) study the distribution of overseas listings using an extensive, hand-collected dataset of nearly the universe of foreign listings in 1998. They find strong evidence that cross-listing activity clusters regionally. The frequency distribution of overseas listings is 38% closer than predicted by a value-weighted distribution. Consistent with Coval and Moskowitz (1999) and Kang and Stulz (1997), the overseas listing bias is particularly acute for small firms producing nontradable output. Controlling for other received explanations of listing behavior, they find that geographic proximity and other variables that reflect the closeness between countries – such as economic, cultural, and industrial proximity – play the dominant role in the choice of overseas host markets for firms from non-G5 countries. They find no evidence of proximity preference among firms from G5 countries. Although proximity appears to be the dominant concern for trading venue selection, other considerations are also important. Sarkissian and Schill (2004) find that firms tend to target overseas listings in equity markets, which are larger, more highly capitalized, and have more a liberal tax environment. They find little support for the hypothesis that overseas listing firms are primarily motivated by diversification gains. Rather than maximizing the diversification gain by listing in markets with little economic correlation with one’s home market, cross-listing activity is more common across markets for which return correlation and beta risk are relatively high. Sarkissian and Schill (2004) note that their results suggest that overseas listings do not overcome, but rather reflect, investor home bias, in contrast to the prevailing wisdom that they mitigate the frictions to cross-border investing by bringing foreign equity to the investor’s home market (Ahearne et al. 2004). Sarkissian and Schill (2004) show that the home bias phenomenon is not just a

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cross-border transaction cost problem, but is also related to familiarity. They do not discriminate between the underlying causes of their results. Although their geographic, economic, cultural, and industrial proximity variables may be related to foreign investor information disadvantage, they may alternatively stand in for the psychological tolerance for these stocks by foreign investors. They find that firms producing “tradable” output experience less bias, but again, this can be attributed to either the superior information or to the greater psychological tolerance generated by exposure to traded products. Pogano et al. (2002) find that common language and similar institutions foster cross-listings. For example, they note that the Vienna stock exchange is the single largest destination for German companies, and the German stock exchange is the single largest destination for Austrian companies. A similar relationship holds true between the United States and the United Kingdom. This “clustering” indicates that companies tend to cross-list in countries that are geographically or culturally close to their country of incorporation. This parallels the findings by Portes and Rey (2005) and Tesar and Werner (1992) that geographic proximity and cultural homogeneity (especially language) enhance cross-border securities transaction flows. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.7 Currency Maggiori, Neiman, and Schreger (2018) note that capital crosses international borders far more today than only a few decades ago. In the late 1970s, almost none of the total outstanding value of U.S. corporate debt was held by foreigners. Today, more than one-quarter is held abroad. In part due to a lack of detailed data, however, surprisingly little is known about the determinants of cross-border investment. Maggiori et al. (2018) introduce a novel security-level dataset with $27 trillion in global investment positions to demonstrate that portfolios at both the macro and micro levels are driven by an often neglected aspect – the currency of denomination of assets. Maggiori et al. (2018) emphasize three findings. First, investors’ bond portfolios exhibit strong home-currency bias as they disproportionately hold bonds denominated in their own country’s currency. Maggiori et al. (2018) identify this effect using micro-data capable of disentangling the currency of denomination of an asset from possible confounding factors such as maturity, legal jurisdiction, and issuer’s credit risk and sector of operation. Investors disproportionally hold bonds denominated in their home currency when choosing among bonds issued in different currencies by the same firm. This bias holds to such an extent that each country owns the vast majority of securities issued in its currency, even when the issuer is foreign and resides in a developed country. In fact, given the currency of a security, knowledge of the issuer’s nationality – the focus of a large and influential literature on home bias – adds very little information about the holder’s nationality. If one considers only the global supply of bonds denominated in a

138 A place-attachment explanation country’s currency, that country’s portfolio exhibits little if any bias toward securities issued by domestic firms. Similarly, there is little or no bias towards domestic firms if one considers only bonds that are not denominated in a country’s currency. Second, this home-currency bias leads to a markedly different allocation of capital across firms. In each country, a small number of large firms issue debt denominated in foreign currency and borrow from foreigners. A large number of medium- or smaller-sized firms issue only in the local currency and borrow little or nothing from foreigners. The size-dependent ability to issue in foreign currency skews foreign capital away from the vast majority of issuers, even in highly developed countries. Maggiori et al. (2018) establish this result not only controlling for observable firm characteristics, but also by using, in the case of publicly-listed firms, the foreigners’ holdings of the firms’ equity as a proxy for the firm’s unobservable attractiveness to foreign investors. Among those firms that issue in multiple currencies, there is a positive relationship between the foreigners’ holdings of equity and bonds. For example, if foreigners are overweight the equity of one of these firms relative to domestic investors, then they are typically also overweight the bonds of the firm. Not so for local-currency firms: Foreigners might hold more or less of the equity of such firms, but they are always markedly underweight the bonds. Third, the global willingness to hold the U.S. dollar renders the United States the unique exception to the above patterns. In addition to their own currencies, foreigners are biased toward dollar-denominated securities, what Maggiori et al. (2018) dub an international-currency bias, when they invest in all destination countries. This implies that when foreigners buy securities in the U.S., they predominantly buy dollar-denominated securities, thus behaving similarly to U.S. domestic investors. Relatedly, U.S. firms that borrow exclusively in dollars are able to place their bonds in domestic and foreign portfolios with comparable ease. This is not true for any other country in the data. Maggiori et al.’s (2018) work offers a novel perspective on the benefits that accrue to countries that issue an international currency like the dollar – these countries effectively open the capital account for their domestic firms that only borrow in local currency. In short, Maggiori et al. (2018) establish that global portfolios are driven by an often neglected aspect – the currency of denomination of assets. Using a dataset of $27 trillion in security-level investment positions, Maggiori et al. (2018) demonstrate that investor holdings are biased toward their own currencies to such an extent that each country holds the bulk of all securities denominated in their own currency, even those issued by foreign borrowers in developed countries. In fact, given the currency of a security, knowledge of the issuer’s nationality adds very little information about the holder’s nationality. While large firms can issue in foreign currency and borrow from foreigners, the vast majority of firms issue only in local currency and do not access foreign capital. These patterns hold broadly across countries with the exception of international currency issuers such as the U.S. The global willingness to hold

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the U.S. dollar, an international currency bias, means that even small U.S. firms that borrow exclusively in dollars have little difficulty borrowing from abroad. Global portfolios shifted sharply away from the euro and toward the dollar, starting with the 2008 financial crisis, further cementing the dollar’s international role and amplifying the benefit that its status brings to the U.S. Maggiori et al. (2018) rationalize these findings in a framework with downward-sloping demand for bonds in each currency in which firms pay a fixed cost to borrow in foreign currency. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.8 International business Curran and Zignago (2012) point out that the fact that many international companies remain strongly oriented towards their home region has been highlighted in the work of several international business scholars. This work has given rise to the concept of the liability of inter-regional foreignness. Within the discipline of international business, there has been quite some discussion in recent years on the key issue of just how international business actually is. That many companies operate beyond the borders of their country of origin is beyond doubt, but the extent to which multinational enterprises (MNEs) are really operating globally in the sense of operating in a balanced manner across all regions of the world is certainly debatable. A key contributor to this debate has been Alan Rugman. Together with his co-authors, he has studied the activities of the 500 largest global companies and has found that they are overwhelmingly focused on countries that are geographically close to them, specifically countries within their home region. As the argument is most extensively developed in his 2004 paper with Verbeke, the following discussion focuses on this work.8 The main argument in Rugman and Verbeke’s (2004) paper is that evidence from the operations of the largest “global” companies indicates that they are less global than regional in their sales activities, and that this observation has important implications for theorizing on international business. In effect Rugman and Verbeke (2004) argue that the liability of foreignness concept, as developed by Hymer (1976), is not universally applicable across all “foreign” destinations. In particular it needs to be unbundled between home and host regions and between downstream and upstream activities. They propose that the concept be expanded to incorporate the liability of inter-regional foreignness (Rugman and Verbeke 2004, p. 16). Rugman mostly exploits data on sales and assets of the Fortune 500. Another approach is to look at figures on foreign direct investment (FDI). These macro figures have the advantage of covering the activities of all companies, not just the very largest. Dunning et al. (2007) exploited such data in their analysis, which found that, although FDI data were slightly less concentrated than the data on the Fortune 500, the figures nevertheless broadly supported the

140 A place-attachment explanation contention of Rugman and his co-authors that MNE operations are heavily concentrated in their home region. The reasons why companies may be both more willing to invest, and more successful in their marketing efforts, in geographically and culturally close countries are not difficult to imagine. As Rugman and Verbeke (2004) have pointed out, there are multiple environmental circumstances that hinder global operations – powerful local competitors; differing consumer preferences; government policy, both deliberate (trade barriers) and accidental (differing regulations); and cultural factors, to name but a few. Rugman and Verbeke’s (2004) paper has fostered several research streams that seek to explore this issue further. As mentioned above, Dunning et al. (2007) have explored FDI figures, Osegowitsch and Sammartino (2008) have questioned the methodology used and pointed out that the cut-off points in Rugman and Verbeke (2004) are rather arbitrary and that the results change if those cut-off points are adjusted. However the change is not drastic, and a propensity to be heavily concentrated in the home region is an undeniable feature of the data, whatever the cut-off point used. Asmussen (2009) reassessed the Rugman and Verbeke (2004) data taking a different approach and reconfirmed the conclusion that large MNEs are overwhelmingly home region-oriented. However his analysis identified a substantial home country effect in the regional data – in other words, by aggregating home country and home region sales, Rugman and Verbeke (2004) may be confusing a tendency to focus on the home country with a tendency to focus on the home region. The larger the home country market, the higher the likelihood of such a home country effect. This observation has been confirmed by Seno-Alday (2009), who also finds evidence (based on a rather small sample of 33 MNEs) that MNEs in large home markets and concentrated regional markets (essentially U.S. MNEs) will tend to be more host region-oriented in their internationalization. What has been relatively little explored in the debate is the question of the extent to which different types of companies and types of product markets may show differing internationalization typologies. Rugman and Girod (2003) explored the figures for retail MNEs and found that they were heavily regional in focus. Retailing is a service sector where expansion into new markets is usually through FDI, which is a substantial resource commitment. Thus, the classic Uppsala school of internationalization theory (e.g., Johansson and Vahlne 1990) could easily explain this limited global presence as related to the unwillingness to commit substantial funds in distant, risky markets and path dependency in terms of existing (less distant and risky) investments. Beleska-Spasova and Glaister (2009) differentiated between service and manufacturing companies in their study of U.K. companies, with rather counter-intuitive results – service firms were less home region-oriented, although more host region-oriented and less global than manufacturing. The authors interpret this as being a reflection of the fact that services are both more location bound and more likely to be regulated, hence service companies may tend to focus their efforts on one or two regions (home and/or host), rather than seeking to operate globally.

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Although international trade data has not yet been heavily exploited in the international business literature, there is extensive existing literature, mainly in the realm of international economics, seeking to explain and predict trade flows, from which some interesting insights emerge. Probably most relevant to the debate on globalization/regionalization are the insights from so called gravity models. Gravity models basically model bilateral trade as being a function of a gravity-like pull related to the size of economies and the distance between them (Anderson 1979). Clearly, economic actors in two countries in the same region are likely to be geographically closer than actors in two different regions, so gravity models tell us that regional trade is likely to be higher in any case than trade beyond the region. This is because of a variety of effects, including the fact that trade costs escalate with distance. Key trade costs include information costs, design costs, and regulatory costs, as well as the cost of physically transporting the good (Anderson and Van Wincoop 2003). Irarrazabal et al. (2010) provide a review of literature on the issue of modelling trade costs. Regional integration initiatives can reduce these costs, not only because of tariff reductions, but also because of regulatory harmonization. Mayer and Zignago (2005) have explored global and regional trade flows using a gravity model, and identified clear and increasing trade creation effects from the regional groupings – European Union (EU), North American Free Trade Agreement (NAFTA), and Association of Southeast Asian Nations (ASEAN). Thus, the liability of inter-regional foreignness identified in the international business literature has parallels in the international economics literature, which has identified the negative impact of geographic distance on trade as well as the stimulating effect of regional integration initiatives. Guiso, Sapienza, and Zingales (2009) ask: How much do cultural biases affect economic exchange? They try to answer this question by using the relative trust European citizens have for citizens of other countries. First, they document that this trust is affected not only by objective characteristics of the country being trusted, but also by cultural aspects such as religion, a history of conflicts, and genetic similarities. They then find that lower relative levels of trust toward citizens of a country lead to less trade with that country, less portfolio investment, and less direct investment in that country, even after controlling for the objective characteristics of that country. This effect is stronger for goods that are more trust intensive, and doubles or triples when trust is instrumented with its cultural determinants. They conclude that perceptions rooted in culture are important (and generally omitted) determinants of economic exchange. Webster’s Dictionary defines culture as “the customary beliefs, social forms, and material traits of a racial, religious, or social group.” Guiso et al. (2009) focus on the first of these dimensions (customary beliefs). Paraphrasing Einstein, they identify culture as “the collection of prejudices acquired by age eighteen.” One can look for the ways in which these customary beliefs impact economic choices. In particular, Guiso et al. (2009) focus on the effect that customary beliefs have on international trade and investments via the effect they have on

142 A place-attachment explanation the degree of trust citizens of a country have toward citizens of other countries. In a world where contract enforcement is imperfect and/or where it is impossible or prohibitively expensive to write all future contingencies into contracts, the degree of mutual trust is an essential component in any economic exchange. Lack of trust will prevent otherwise profitable trade and investment opportunities. Guiso et al. (2009) focus on the role customary beliefs have on trust, and argue that culture plays a role in the formation of trust beyond what objective considerations would justify, and show how these cultural biases impact international trade and investments. Guiso et al. (2009) measure cultural stereotypes with three variables – commonality in religion; similarity in ethnic origin; and the history of wars between two countries in the past millennium. As a measure of similarity in culture that is unrelated to better objective reasons to trust, Guiso et al. (2009) use commonality of religion. As a measure of somatic similarities, they use the genetic distance between indigenous populations. While genetic distance does not necessarily express itself in somatic differences, it does represent the evolutionary distance between two populations. Guiso et al. (2009) use genetic distance because it correlates with anthropometric traits. That people “love those who are like themselves” was recognized by Aristotle. It is well-known that people with similar cultural backgrounds and similar appearances tend to trust each other more (Bornhorst et al. 2004; McPherson, Smith-Lovin, and Cook 2001). In their sample, Guiso et al. (2009) see that this love for the similar translates into higher levels of trust: In almost all the countries studied, people trust a generic fellow citizen much more than a generic citizen of any other country. To capture the implicit positive or negative bias against other nations present in a country’s cultural tradition, Guiso et al. (2009) also use its history of wars. People’s prior beliefs can be affected by their education and in particular by the history they study in school. Italian education, for instance, emphasizes the struggles that lead to the reunification of the country in the 19th century. Since the major battles during this period have been fought against Austria, Italian students may develop, as data show, a negative image of Austrians. These findings are consistent with Bornhorst et al (2004), who find that cultural stereotypes affect the level of trust in an experimental setting. After establishing an effect of culture on prior beliefs, Guiso et al. (2009) use these cultural variables as instruments to show how, through its impact on trust, culture affects economic exchange between two countries. In their attempt to explain several international exchange puzzles, Guiso et al.’s (2009) paper is similar to that of Portes and Rey (2005); however, as a key determinant the latter consider not trust but differences in information, which they measure as telephone traffic between two countries and as number of local branches of foreign banks. Guiso et al.’s (2009) paper is also related to that of Morse and Shive (2011) and Cohen (2008). Morse and Shive (2011) relate portfolio choices to the degree of patriotism of a country. Cohen (2008) shows that employees’ bias toward investing in their

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own company is due not to information, but to some form of loyalty toward their company. Both these papers, thus, illustrate one specific dimension in which cultural biases can affect economic choices. Guiso et al.’s (2009) paper uses a broader definition of cultural bias and tries to show the pervasiveness of its effects. On the other hand, some scholars study the effect of institutional quality and regulatory homogeneity on international exchange. While their findings can be explained in terms of similar cultures breeding higher trust, they are also consistent with other, more traditional explanations (information, ease of access to legal remedies, etc.). Guiso et al. (2009) go beyond these results and show that trust matters even after we account for these institutional similarities. In short, in their paper Guiso et al. (2009) show that culture plays a role in the formation of trust, beyond what objective considerations would justify. Even after controlling for a country’s objective characteristics and for differences in the information sets, historical and cultural variables affect the propensity of the citizens of a country to trust the citizens of another country. Guiso et al. (2009) also document that these differences in trust affect the level of economic exchange between two countries – trade, portfolio investments, and FDI. This effect fades as more information about the country to be trusted becomes available in the trusting country. This is consistent with Guiso et al.’s (2009) conjecture that culture plays a role in shaping prior beliefs in the absence of data. The role of migrant networks in facilitating bilateral trade has been studied by Gould (1994) for the United States and by Head and Reis (1998) for Canada. Aizenman (2004), Heathcote and Perri (2013), and Lane (2000) show a positive relationship between trade openness and foreign equity holdings, looking at a cross-section of countries. Aviat and Coeurdacier (2007), Lane and Milesi-Ferretti (2008), and Portes and Rey (2005) show that country equity portfolios are strongly biased toward trading partners. Rauch (1999) shows that geographic and cultural proximity is important in matching international buyers and sellers, not only for products that are not traded on organized exchanges, but also to a lesser extent for those that are traded. Brainard (1997) finds that firms are more likely to undertake a multinational activity in those foreign markets that are similar to the home market. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.9 International trade Li, Li, and Luo (2016) note that cross-border trades have received the attention of research in the field of international trade in the past several decades. McCallum (1995) finds a puzzling sizable trade reduction across the Canada–U.S. national border. Subsequent studies confirm the existence of this phenomenon, and consider it one of the six problems in international macroeconomics (Obstfeld and Rogoff 2001). International borders impede trade because national borders can be

144 A place-attachment explanation proxies for a wide range of trade frictions, such as unobserved government interventions, exchange rate variability, trade openness, and cultural and language barriers. However, in intra-regional trade within one country, most of these factors can be assumed nonexistent. Therefore, border effects can be reasonably expected to be insignificant in inter-regional trade. However, even in such an advanced economy as the United States, border effects continue to exist in inter-state trade. Existing literature explains that the inter-state border effect is caused by two factors. The first is consumers exhibiting home bias, sometimes called the effect of culture, a psychological phenomenon in which consumers tend to buy products produced locally. The second factor is the effect of unobserved policy barriers and transaction costs.9 Hillberry and Hummels (2003) ask: Why do political boundaries shape the geographic pattern of trade? This question has attracted considerable attention since McCallum’s (1995) finding that Canadian inter-provincial trade was 22 times larger than province–state trade. Though the magnitude of McCallum’s estimate is surprising, one can certainly identify reasons why international borders impede trade. Presumably, national borders proxy for a wide range of trading frictions, including tariffs and nontariff measures imposed intentionally by national governments, as well as costs associated with customs clearance and currency change that inevitably arise when shipping goods across differing national jurisdictions. Such frictions are notably absent in trade between U.S. states, which are constitutionally enjoined from impeding interstate commerce. Yet, it still appears that state borders inhibit trade flows. Using the public sample of the 1993 U.S. Commodity Flow Survey, Wolf (2000) estimates that intra-state trade was more than four times larger than trade between states. This prompts two questions. One, why do arbitrarily drawn political boundaries, like U.S. state borders, appear to pose a barrier to trade? Two, is there economic significance to these borders that has not been previously appreciated? An answer may be found by noting that Wolf’s (2000) data included shipments originating in both manufacturing and wholesale establishments. One can broadly think of manufacturers and wholesalers as a kind of hub-and-spoke arrangement. Goods are manufactured in the hub and dispersed, sometimes at great distances, to a number of wholesaling spokes spread throughout the country. The wholesaling spokes then distribute, over very short distances, to retailers. As a result, lumping wholesaling and manufacturing shipments together may provide a misleading picture of spatial frictions. The reason that manufacturers would choose to employ this huband-spoke system is itself quite interesting and informative about spatial frictions. Put another way, one might ask: if manufacturers find it easy to ship over long distances, why don’t wholesalers? And the answer may be that the kinds of geographic frictions wholesalers face are quite different from those faced by manufacturers. Several possibilities suggest themselves. Wholesaling may be employed in order to efficiently manage inventories and respond rapidly to demand fluctuations.

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Hub-and-spoke systems may also be used to exploit the relative efficiency of long- and short-haul transportation modes. That is, manufacturers employ large trucks or rail when shipping to wholesalers, whereas wholesalers employ smaller trucks when shipping to retailers. In both cases, wholesale shipments are exceedingly local relative to manufacturing shipments, because the cost of some geographic frictions related to distribution rise sharply in stages of the value chain immediately prior to consumption. Returning to Wolf’s (2000) result, it is not that state borders matter, per se, but that borders proxy for very short shipment lengths. It may also be that the political boundaries are of direct interest due to contractual stipulations binding on wholesale shippers. Manufacturers are legally allowed to segment markets by designating explicit geographic boundaries that their wholesalers are not allowed to cross. Such segmentation may be an effective way to engage in resale price maintenance, and state boundaries are an obvious way to divide territory. All three explanations can be thought of as kinds of geographic frictions, but they are quite different from straightforward transportation cost frictions typically supposed. The question then becomes whether the responsiveness of shipments to geographic frictions depends as much on the nature of the shipper as on the good being shipped. If so, then this is informative about the nature, as well as the size, of the frictions in question. To answer these questions Hillberry and Hummels (2003) employ a private-use sample of the 1997 U.S. Commodity Flow Survey. Their results suggest that state border effects are still significant, but roughly a third as large as Wolf (2000) estimates. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.10 International marketing Consumers have a preference bias toward consuming domestic goods. This bias is confirmed by the empirical observation that the majority of private consumption falls on domestic goods, that is, consumer ethnocentrism.10 The international marketing literature provides a social identity theory explanation of consumer behavior regarding the tendency to favor domestic products and reject foreign products. Considerable theoretical and empirical effort has been invested in studying the phenomenon of domestic country bias (Balabanis and Diamantopoulos 2004) by invoking constructs such as consumer ethnocentrism (e.g., Shimp and Sharma 1987; Siamagka and Balabanis 2015), national identity (e.g., Dmitrovic, Vida, and Reardon 2009; Verlegh 2007), and economic nationalism (e.g., Cheah and Phau 2015; Lee, Kyung, and Lee 2014). Similarly, researchers have extensively studied the bias against product purchase from foreign countries, utilizing the consumer animosity construct as the key

146 A place-attachment explanation explanatory variable (Klein 2002; Klein, Ettenson, and Morris 1998; Riefler and Diamantopoulos 2007). The literature describes the concept of consumer ethnocentrism as a means to understand the moral concerns arising from the consumption of foreign and domestic products. Consumer ethnocentrism is a derivative of the general concept of ethnocentrism first introduced in the sociology domain. Sumner (1906, p. 13) originally defined the concept of ethnocentrism as “the technical name for this view of things in which one’s own group is the center of everything, and all others are scaled and rated with reference to it.” According to Sumner, the main features of ethnocentrism include pride in one’s own group and a perception of other groups’ inferiority. The “we” group is characterized by feelings of superiority and pride, while the “others” group is perceived as inferior. Adorno et al. (1950) provide an augmented overview and a scale to measure ethnocentrism, in which ethnocentrism serves as an expression of authoritarianism. According to Adorno et al.’s theory, ethnocentrism is a pervasive personality trait that is part of one’s ideological system (see also Forbes 1985). The “authoritarian personality” is grounded in Freudian psychoanalytic theory, and its emphasis is on early childhood experiences that shape personality development. LeVine and Campbell (1972) suggest that ethnocentrism is precipitated by social factors and competition of groups for scarce resources (e.g., jobs, economic resources), in what has become known as the realistic group conflict theory. Recent evidence from longitudinal research supports the view that ethnocentrism has the enduring nature of a personality trait and is not affected by social factors such as size and proximity of outgroups and ethnic diversity (Bircan 2010; Hooghe, Reeskens, and Stolle 2007). Shimp and Sharma (1987, p. 280) first defined consumer ethnocentrism, an offshoot of Adorno et al.’s (1950) view of ethnocentrism as a personality trait, as the “appropriateness, indeed morality, of purchasing foreign-made products.” According to them, to an ethnocentric consumer, purchasing imported products is immoral and unpatriotic, hurts the domestic economy, and leads to a loss of domestic jobs. Ethnocentric consumers tend to perceive domestic products as superior to foreign alternatives. This notion is in line with LeVine and Campbell’s (1972) view of ethnocentrism, in which domestic values and symbols are perceived with pride, whereas foreign ones are viewed with contempt. With this perception, consumers exhibit a systematic preference for domestic goods, accompanied by a rejection of foreign alternatives. Consumer ethnocentrism serves to provide people with a sense of belonging to a group, as well as direction regarding what is appropriate or inappropriate purchasing behavior. Parallel to Smith’s (1992) view that ethnocentric sentiments are deeply rooted in human values, consumer decision making also includes strong moral and social considerations. The reason for this association with morality lies in the principles of moral values, or actions that are likely to be helpful or harmful to humans in the long run (McGregor 2006). Shimp and Sharma (1987) use the general term tendency, rather than attitude, to describe consumer ethnocentrism. According to them, tendency captures the

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more general notion of a disposition to act in a consistent manner toward foreign products in toto. Sharma, Shimp, and Shin (1995, p. 27) later defined consumer ethnocentrism as “a trait-like property of individuals’ personalities,” emphasizing the enduring nature of ethnocentrism. Unlike attitudes, personality traits are not evaluative and descriptive response tendencies in a given domain (Ajzen 2005). Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.11 Mergers and acquisitions Uysal, Kedia, and Panchapagesan (2008) examine the impact of geographic proximity on the acquisition decisions of U.S. public firms over the period 1990–2003. Transactions where the acquirer and target firms are located within 100 kilometers of each other are classified as local transactions. Uysal et al. (2008) find that acquirer returns in local transactions are more than twice that in nonlocal transactions. The higher return to local acquirer is not explained by related (either horizontal or vertical) industry transactions, and appears to be related to information advantages arising from geographic proximity. These information advantages facilitate acquisition of targets that, on average, create higher overall return. The higher return to local acquirers is preserved by the use of target termination fee contracts. More specifically, Uysal et al. (2008) note that several decades of research in mergers and acquisitions has documented the importance of synergies in creating value. These synergies have been shown to arise from vertical and horizontal relatedness. In their paper, Uysal et al. (2008) examine another potential source of synergy: Geographic proximity between a bidder and a target, and its role in the creation and distribution of value in mergers and acquisitions. Uysal et al. (2008) state that synergies from geographic proximity are likely to arise from more efficient sharing of common facilities and human capital between firms. The advantage of proximity has been documented in takeovers in the banking industry. Cornett and Tehranian (1992), DeLong (2001), Houston and Ryngaert (1994), and Houston et al. (2001) find larger gains associated with mergers between banks that do business in the same region. Though these studies examine mergers in the banking industry during deregulation, similar synergies are likely to exist in other industries as well as in cross-industry transactions. Eckbo and Thorburn (2000) document that Canadian bidders outperform U.S. bidders in Canada, indicating that geographic proximity also has a role to play in cross-border mergers. Spiller (1985) finds a similar advantage to proximity in vertical mergers. Uysal et al. (2008) further note that an increasing and diverse literature documents the role of geographic proximity in the transmission of information. Geographic proximity is associated with knowledge spillovers, resolution of information problems in bank lending, and more accurate earnings forecasts by analysts.11 Information advantages associated with geographic proximity have

148 A place-attachment explanation also been found to explain the local bias observed in mutual fund investments as well as in the portfolio decisions of individual investors.12 In addition, Malloy (2005) reports that local equity analysts predict the future earnings of geographically proximate firms more accurately than their distant counterparts. Geographic proximity between the acquirer and the target is likely to facilitate the transmission of soft information, which is difficult to codify and is often serendipitously recognized, as opposed to hard information that is tangible and can be easily coded, transmitted, and interpreted. For example, financial statements provide meaningful information on physical assets, whereas they are less useful in evaluating the productivity and value of knowledge-based assets like research and development. Local acquirers may have access to soft information through the interactions of their managers in social, civic, and business meetings. Transmission of information could also be facilitated by the existence of common customers, suppliers, and financial and information intermediaries such as banks and the media. Consequently, geographically proximate bidders may have access to more information about the target than distant bidders. Uysal et al. (2008), moreover, note that the existence of informed acquirers has important implications for takeovers. First, information advantages may facilitate discovery of less obvious forms of synergies. These synergies involving the acquisition and evaluation of soft information are quite distinct from the operational synergies discussed above. For example, proximity may help acquirer and target firms discover promising collaborative research and development ventures. Jaffe et al. (1993) find that geographic proximity facilitates collaborative research among the scientists of nearby firms. Scientists are more likely to engage in these collaborative efforts under the aegis of a single firm. The existence of operational and information-based synergies implies that proximate deals are likely to generate higher value. Further, local acquirers should capture some of the higher value created, as these are specific to his/her being local. This is more likely to be the case if there are few other potential local acquirers. Second, theoretical work like that of Fishman (1988) and Povel and Singh (2006)13 explicitly models the presence of both informed and uninformed bidders and its impact on the division of the surplus created in takeovers. In particular, this literature shows that informed acquirers earn higher rents relative to what they would earn in the absence of information asymmetry. The presence of information asymmetry between bidders implicitly reduces competition, as the uninformed bidder is more likely to be subject to the winner’s curse problem. An uninformed bidder who wins the takeover contest after beating the informed bidder is more likely to have overpaid. Povel and Singh (2006) argue that these higher rents to the informed acquirer are protected by the use of deal protection devices like target termination fees. Uysal et al. (2008), in summary, state that regardless of whether geographic proximity is associated with higher synergies or asymmetrically informed

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bidders, proximate acquirers should earn higher returns. Uysal et al. (2008) examine the role of geographic proximity on acquirer returns in a sample of all completed domestic transactions involving mergers and acquisitions of majority interest by a U.S. bidder between 1990 and 2003. A bidder is classified as geographically proximate or “local” if the bidder’s headquarters is located within 100 kilometers of the target firm. Uysal et al. (2008) find that bidders who are geographically proximate to their targets earn significantly higher returns than distant bidders. The average five-day cumulative abnormal return ([–2, +2] days around announcement) is 2.37% for local transactions compared with 0.90% for nonlocal transactions. This higher acquirer return is observed in the acquisition of both public and private targets, as well as in asset purchases, and is robust to controlling for target and deal characteristics. Surprisingly, there is no evidence that local transactions are predominantly within the same industry or that local acquirers earn higher returns in same-industry deals relative to cross-industry deals. Higher synergies or reduction in local competition in same-industry local deals do not appear to explain the higher local return. There is also no evidence that local deals proxy for transactions that are vertically related, or that the higher return to local acquirers arises from higher synergies in vertically related transactions. In short, higher synergies in same-industry and vertical industry mergers do not appear to explain the observed return to local bidders. Other potential reasons, such as a higher probability of deal completion and lower information leakage in a local deal prior to the announcement, also fail to explain the higher return to local acquirers. Soft information arising from geographic proximity is more valuable when the quality of the target firm’s assets is difficult to measure and there is uncertainty about the extent of synergies (Coff 1999). Consistent with this, Uysal et al. (2008) find higher local acquirer returns when the target is nonpublic, small, R&D intensive, located in a non-metro area, and has no analyst coverage. As information advantages may dissipate after the announcement of the transaction and before it is effective, Uysal et al. (2008) find that target termination fee contracts protect the higher return to the local acquirer, making it difficult for these higher returns to be competed away. These results substantiate the view that information advantages play an important role in explaining the higher return to local acquirers. Uysal et al. (2008) results provide a new dimension to patterns of value creation in mergers and acquisitions. Though most prior literature finds that acquirers earn, on average, a zero return in their acquisitions, Uysal et al. (2008) document the importance of an acquirer’s characteristics, in particular, its information advantages in the generation and distribution of value in these transactions. The findings complement the results of papers by Fuller et al. (2002) and Moeller et al. (2004) that document that average return to acquirers is significantly positive when the targets are not publicly traded and for small acquirers, respectively.

150 A place-attachment explanation The use of geographic proximity to capture information differences allows Uysal et al. (2008) to empirically document the importance of private information for takeover outcomes. Uysal et al. (2008) find that informed bidders are able to use their information advantages to undertake acquisitions that, on average, create more value and get a share of the surplus for themselves. Cai, Tian, and Xia (2016) examine how the geographic location of firms affects acquisition decisions and value creation for acquirers in takeover transactions. Cai et al. (2016) find that firms located in an urban area are more likely to receive a takeover bid and complete a takeover transaction as a target than firms located in rural areas, and takeover deals involving an urban target are associated with higher acquirer announcement returns, after controlling for the proximity between the target and the acquirer. In addition, a target’s urban location significantly attenuates the negative effect on acquirer returns of a long distance between the target and the acquirer, a fact that is documented in the existing literature. Cai et al.’s (2016) findings reveal a previously underexplored force – firm location – that can affect takeover transactions, in addition to proximity. Cai et al.’s (2016) paper suggests that a firm’s location plays an important role in facilitating the dissemination of soft information and enhancing information-based synergies. More specifically, Cai et al. (2016) note that better communication of soft information can help the acquirer and the target to mutually discover informationbased synergies (e.g., collaborative research and development ventures) and hence create higher values for both parties (Kang and Kim 2008; Uysal et al. 2008). However, unlike hard information that is largely tangible and easy to verify and communicate, soft information is difficult to codify and transmit (Liberti and Petersen 2019). The communication of soft information – such as evaluations of knowledge-based assets and managerial skills – demands an acquirer’s intensive interpersonal interactions with the target on social, civic, and business occasions (Uysal et al. 2008). This feature of soft information, in turn, makes the acquirer location and the target location important as they determine the accessibility between the two parties in a mergers and acquisitions transaction. Cai et al. (2016) further note that, taken together, these findings suggest a significant role of both the target and the acquirer locations in a takeover transaction, and this role functions in addition to the effect of proximity. The economic magnitudes of these effects are also sizable. For example, a firm located in an urban area is 41.2% more likely to receive a takeover bid than a nonurban firm, and the acquirer’s five-day announcement abnormal returns with an urban target are 27 basis points higher than those with a nonurban target. In addition, whereas a one standard deviation increase (810 miles) in the proximity of the two parties lowers the acquirer announcement returns by 130 basis points, the target’s urban location attenuates this negative effect by 93%. This attenuation effect is even more pronounced when the acquirer does not already have convenient access to the target.

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Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.12 Economic nationalism Dinc and Erel (2013) study government reactions to large corporate merger attempts in the EU during 1997 to 2006 using hand-collected data. Dinc and Erel (2013) document widespread economic nationalism in which the government prefers that target companies remain domestically owned rather than foreign owned. This preference is stronger in times and countries with strong far-right parties and weak governments. Nationalist government reactions have both direct and indirect economic impacts on mergers. In particular, these reactions not only affect the outcome of the mergers that they target, but also deter foreign companies from bidding for other companies in that country in the future. Dinc and Erel (2013) note that corporate mergers and acquisitions are an important part of a market economy. Large firms often enter into a new market through acquisitions of local firms. If there is excess capacity in a sector, weak firms often exit the economy, not necessarily through bankruptcy, but by being acquired by another firm. When such mergers take place between companies from different countries, national economies become more integrated. Yet, the reaction of governments to merger attempts often seems to be motivated by concerns other than competition. In particular, government interventions often appear to depend on the “nationality” of the acquiring company. Nationalist interventions by domestic governments do not simply take the form of opposition to foreign acquirers. They also include support for domestic acquirers to create domestic companies that are considered too big to be acquired by foreigners. Dinc and Erel’s (2013) study of economic nationalism uses hand-collected data on government reactions to individual merger attempts in the 15 EU countries (as of 1996) from 1997 to 2006. Dinc and Erel (2013) show that domestic governments are more likely to support domestic acquirers and oppose foreign ones even though the EU treaty does not leave them with jurisdiction to rule in merger attempts on the basis of nationality. These results are robust to controlling for target, acquirer, and bid characteristics; macroeconomic conditions; as well as target industry, target country, and year fixed effects. Dinc and Erel (2013) also demonstrate that nationalism has not only a direct impact on the outcome of the merger for which it is targeted, but also, and perhaps more importantly, an indirect deterrent effect on future foreign bids for other firms in that country. In other words, nationalism affects international investment and capital flows even if they are not the direct targets of a particular nationalist intervention. Dinc and Erel (2013) further show that nationalist interventions are more frequent when preferences for natives over foreigners in both the social and the economic domains are stronger. Dinc and Erel (2013) measure the importance

152 A place-attachment explanation of such preferences by the vote share of extreme right parties, for which preferences for natives and against foreigners are defining issues in Europe, and by survey evidence. Dinc and Erel (2013) also find that nationalist reactions are stronger under weaker governments, in countries holding the rotational presidency of the EU, and against firms in countries for which the people in the target country have little trust or affinity. Dinc and Erel (2013) do not find a significant effect for unemployment, GDP growth, or the ideology of the prime minister in the target country. The study of nationalism in economics has a long history, and Dinc and Erel (2013) follow an old tradition in using the term “economic nationalism” to refer to the preference for natives over foreigners in economic activities.14 Of this earlier literature, the paper closest to Dinc and Erel (2013) might be Golay (1958), who studies the impact of such preferences on the ownership of firms in post-colonial Southeast Asia. Much of this literature focuses on trade protectionism. Interestingly, EU countries, on which Dinc and Erel (2013) focus, have some of the most liberal policies in the world with respect to the flow of goods and capital, at least among themselves. Furthermore, Dinc and Erel’s (2013) study focuses on some of the richest countries in the world, unlike recent work on economic nationalism that focuses on less developed countries.15 While economic nationalism is unlikely to be restricted to Europe only, Dinc and Erel (2013) chose to focus on large merger attempts in the EU, which provides an ideal setting for a study of this kind for several reasons. First, for large mergers across national borders in the EU, the European Commission, not the national governments, is the antitrust authority. Hence, a nationalist policy by domestic governments cannot be disguised as pro-competition policy. In fact, the member countries of the EU rarely have de jure power to block any merger based on the acquirer’s nationality; instead, they have to rely on their de facto power. Second, Europewide economic integration is unlikely to be complete. Indeed, there still seem to be many opportunities for cross-border mergers, especially following the recent financial crisis. A study of the impediments to this integration is therefore important. Third, there have been a sufficient number of domestic and crossborder merger attempts within the EU to allow for statistical analysis. Finally, a large body of anecdotal evidence points to economic nationalism in the EU. Dinc and Erel (2013), furthermore, note that the recent crisis has only increased the importance of economic nationalism. Many firms are distressed and likely to exit their industry. Given widespread weaknesses in a given country, a potential acquirer may be more likely to be found in other countries. Yet calls for political intervention in the economy in general, and for protectionism in particular, have increased in the popular press. Considering the role of protectionism in deepening and spreading the Great Depression around the world (Irwin 1998), an analysis of economic nationalism and its impact is timely. Dinc and Erel’s (2013) paper is related to several recent studies that examine the role of merger regulations in the European context. Aktas, de Bodt, and Roll (2004), Carletti, Hartmann, and Ongena (2015), and Duso, Neven, and Roller (2007) study the stock market response to regulatory decisions or

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legislative actions using event study methodology. However, Dinc and Erel’s (2013) focus and methodology are different. Bottazzi et al. (2016) and Guiso et al. (2009) demonstrate the importance of trust in cross-border financial investments by using macroeconomic and venture capital investment data, respectively. Ahern, Daminelli, and Fracassi (2015) also use macroeconomic data, and find that the volume of cross-border mergers is smaller when countries are more culturally distant. In contrast, Dinc and Erel (2013) focus on nationalism and use micro-level mergers and acquisitions data as well as hand-collected data on actual government reactions.16 Finally, Morse and Shive (2011) find that country-level patriotism is significantly related to the home bias in equity investments, and Gupta and Yu (2009) show that bilateral capital flows reflect bilateral political relations. Unlike these studies, Dinc and Erel’s (2013) study is at the micro level. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.13 Corporate governance Kang and Kim (2008) use a large sample of partial block acquisitions to examine the importance of geographic proximity in corporate governance and target returns. They find that block acquirers have a strong preference for geographically proximate targets, and that acquirers that purchase shares in such targets are more likely to engage in post-acquisition target governance activities than are remote block acquirers. Moreover, the targets of these acquirers realize higher announcement returns and better post-acquisition operating performance than do targets of other types of acquirers, particularly when they face greater information asymmetries. Kang and Kim (2008) note that it is well known that, despite the substantial gains from international diversification, investors exhibit a strong preference for domestic stocks (French and Poterba 1991; Kang and Stultz 1997). Recent studies show that this so-called home bias phenomenon in international portfolio selection exists even in domestic portfolio selection, and that investment returns in local holdings are higher than those in nonlocal holdings. For example, Coval and Moskowitz (1999) show that U.S. mutual fund managers exhibit a strong preference for local stocks, and using data on individual investments, Ivkovic´ and Weisbenner (2005) and Zhu (2002) find that a strong preference for local stocks also exists for individual investors. Coval and Moskowitz (2001) and Ivkovic´ and Weisbenner (2005) also show that U.S. mutual fund managers and individual investors, respectively, earn significant abnormal returns on geographically proximate investments. Several studies establish that the observed local bias is largely driven by information asymmetry between local and distant investors. For example, Coval and Moskowitz (1999) show that the extent of the local bias is higher for small, highly leveraged firms that produce nontraded goods, and Ivkovic´ and Weisbenner (2005) find that abnormal returns for local investments are higher among non-S&P 500 index stocks for which information asymmetry problems are severe. Similarly, using a

154 A place-attachment explanation large sample of analysts, Malloy (2005) shows that geographically proximate analysts issue more accurate earnings forecasts than do other analysts, and that this accuracy is strongest for firms located in small cities or remote areas.17 Overall, these findings suggest that investors and analysts located near a firm have an information advantage over other investors and analysts with respect to the firm, possibly due to relatively easier access to value-relevant information about the firm, and that this information advantage allows geographically proximate investors to earn superior returns from their investments. Kang and Kim (2008) extend the new literature on geographic proximity by studying how both corporate governance activities of block acquirers in targets, and target announcement returns, are affected when the acquirers are located near the targets. Kang and Kim (2008) take the information asymmetry that arises from geographic proximity to be a key determinant of block acquirers’ governance activities in targets and target announcement returns. The rationale for this prediction is twofold. First, geographically proximate acquirers should enjoy significant information advantages with respect to local targets. For example, acquirers located near targets have better access to information than remote acquirers because they can more easily obtain valuable private information about the targets through informal talks with CEOs, employees, and customers, or they can more readily visit the targets and directly observe the targets’ operations. It is also possible that, compared with remote acquirers, acquirers located near targets expend less time collecting information about their targets as they are on the spot. These information advantages provide block acquirers of geographically proximate targets with enhanced monitoring capabilities, and thus, stronger incentives to monitor their proximate targets. Second, monitoring of target management involves substantial costs, costs that are likely to increase with the distance between the acquirers and their targets because monitoring of remote targets usually requires increased communication and transportation costs. For example, Sussman and Zeira (1995) present a model in which banks face monitoring costs that increase with distance. Consistent with this prediction, Petersen and Rajan (2002) and Degryse and Ongena (2005) show that transportation costs cause price discrimination in bank lending. Similarly, in the context of U.S. venture capital, Lerner (1995) finds that the board membership of venture capital in private biotechnology firms is partly determined by the distance between firms and venture capitalists. He argues that the large monitoring costs associated with frequent visits to the firm and intensive involvement in the firm’s operation discourage more remote venture capitalists from actively participating in governance activities in the firm. Kang and Kim (2008) further state that these arguments suggest that, compared with remote acquirers, geographically proximate block acquirers have significant advantages in their ability to actively pursue post-acquisition target governance activities. To the extent that increased or enhanced monitoring activities translate into better firm performance, these arguments also suggest that targets of geographically proximate acquirers should experience both higher abnormal announcement returns and better post-acquisition operating

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performance than other types of target. Further, to the extent that the benefits of monitoring are likely to be especially valuable for firms that are perceived by the market as having high information asymmetries, positive target announcement returns and post-acquisition operating performance should be particularly pronounced when targets are small or risky, when they have a higher level of R&D investments, when they have high insider ownership, or when they experience poor past performance. Kang and Kim (2008) use state identifiers and physical distance as their primary measures of geographic proximity, and find results that are consistent with the predictions above. Defining a partial acquisition as one in which the bidding firm acquires at least 5% but less than 50% of the target’s voting shares, for a sample of 799 partial acquisitions in the United States during the 1990 to 1999 period, Kang and Kim (2008) find that geographically proximate block acquirers are more likely to be involved in post-acquisition governance activities in targets than are remote block acquirers. Specifically, acquirers located within the same state as the target (referred to as in-state acquirers) and those located within 75 miles or 100 kilometers of the target (referred to as local acquirers) are more likely to have their representatives on the target’s board and to replace poorly performing target management after block share purchases. Therefore, information advantages that arise from geographic proximity provide block holders located near targets with strong incentives to actively monitor target managers, fostering corporate governance activities in targets. To the extent that investors’ monitoring costs increase with physical distance from the target – because of extra communication and transportation costs – the results also suggest that monitoring costs are an important determinant of governance activities of acquirers in targets. Furthermore, targets of in-state acquirers and those of local acquirers experience both higher abnormal announcement returns and better post-acquisition operating performance than those of other acquirers. The positive valuation effects are more pronounced when targets are smaller, when targets are riskier, when targets have a higher level of R&D investments, when targets experience worse past performance, or when targets have higher insider ownership. The effects are also particularly strong for geographically proximate targets in which the acquirers have their representatives on the targets’ boards. To the extent that the benefits of monitoring are likely to be more valuable for targets that have greater information asymmetries, such as small or risky targets, targets with high R&D intensity, targets with poor past performance, and targets with high insider ownership, and that local information related to these targets is more difficult to obtain by nonlocal acquirers, Kang and Kim’s (2008) findings also suggest that geographically proximate investors are better able to exploit their informational advantage when local firms have opaque information environments. Kang and Kim (2008) also examine whether block acquirers exhibit a bias toward geographically proximate targets. They find that the actual fraction of targets acquired by firms located in the same state is 19.77%, while the mean

156 A place-attachment explanation and median expected probabilities of being acquired by firms located in the same state (the fraction of all public firms that reside in a certain state relative to all public firms in the U.S.) are only 7% and 5.44%, respectively. Thus, block acquirers exhibit a strong preference for targets located near them, indicating that geographic proximity plays an important role in determining acquirers’ choice of targets. Kang and Kim (2008) warn that targets in their sample are relatively small, with a median book value of total assets of only about $68 million. This small sample bias limits their ability to generalize these findings to other settings in which targets involved in acquisitions are large. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.14 Accounting standards U.S. generally accepted accounting principles (GAAP), International Accounting Standards (IAS), and other standards (e.g., German Standards) compete for international acceptance around the world.18 Bartov, Goldberg, and Kim (2005) note that it is common practice in the accounting literature to distinguish between two models under which accounting standards are developed: The shareholder model, originating in countries with a common-law legal system; and the stakeholder model, originating in countries with a code-law legal system. In a pure shareholder- or common law-model country, companies raise capital (equity and debt) directly from the public, and investors are presumed to rely on public, not private, information. Consequently, common law systems tend to require a high standard of public disclosure, and accounting rules are determined largely by the disclosure needs of shareholders and prospective shareholders. The problem of asymmetric information between managers and shareholders is addressed through financial reporting and other means of timely public disclosure. Accounting standards evolve by becoming commonly accepted in practice and are generally separate from tax laws. In other words, accounting standards arise in an accounting market and are not determined by the government. Conversely, in a pure stakeholder- or code law-model country, taxation requirements largely encumber financial reporting rules, and the government, shareholders, debt holders, employees, and managers are all viewed as stakeholders. In code-law countries, transactions are frequently conducted among parties that know each other. There is less reliance on public information and investors typically have access to private information. Code-law systems, therefore, tend to require a lower standard of public disclosure and thus generate less public information. Consequently, code-law systems do not support large public capital markets. Rather, they tend to rely on intermediaries such as banks. For example, a corporation raises debt and equity capital in relatively large amounts from a bank with which it has a long-term relation. The bank, which serves as an intermediary, in turn raises the capital from the public. The

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bank has access to private information about the corporation’s risks, which need not be publicly disclosed. While pure common-law countries and pure code-law countries do not exist in reality, the Anglo-American countries (e.g., the United States and the United Kingdom) are typically classified as common-law countries, whereas most continental European countries (e.g., Germany) and Japan are classified as code-law countries. In Germany, traditionally, banks play a key role in providing finance and representing investors. Agents of stakeholders tend to be informed by private and inside access to information. This reduces the need for timely public disclosure of income. Also, the incentives and opportunities to minimize earnings and to reduce its volatility are high in Germany. The incentives follow because financial reporting is the same as tax reporting, and because income tax rates are progressive. The opportunities include the liberal reserve accounting rules and choices given to company managers regarding the timing in which accelerated depreciation is to be applied. In summary, code-law accounting provides greater incentives and opportunities to minimize and/or smooth income than common-law accounting. These reporting goals are achieved at the expense of timeliness of conveying value relevant information. While both U.S. GAAP and IAS are set primarily by the private sector and focus on investors’ needs, differences exist between these two sets of rules. In a comparison between U.S. GAAP and IAS, FASB (1999) found 250 key differences in four categories: Recognition, measurement, permissible alternatives, and lack of guidance or requirements. The FASB concludes that IAS is of lower quality than U.S. GAAP (Wall Street Journal 1999). The EU, which is considering requiring companies listed on European stock exchanges to adopt IAS, disagrees. For example, an EU spokesman was quoted in the Wall Street Journal (2002) as saying “We believe IAS is superior to GAAP. We believe it offers investors the best view of the situation of a company in which investor might want to invest.” Demski (1973) states that a primary goal of accounting theory is to explain which accounting alternative should be used (in some particular circumstance). Numerous attempts to develop such a theory have, of course, been offered through the years. Most of these attempts have, in turn, relied on standards, such as relevance, usefulness, objectivity, fairness, and verifiability, to delineate the desired alternatives. Social choice institutions also reflect this reliance on standards, with the recently formed Financial Accounting Standards and Cost Accounting Standards Boards. Demski (1973) further states that these standards are usually viewed in terms of, or applied to, the accounting measurement process, the environment in which the measurements are taken and/or used, and perceptions regarding that environment. But any such application that is removed from individual preferences – in the slightest manner – creates an insurmountable difficulty. In particular, no normative theory of accounting can be constructed using any

158 A place-attachment explanation such set of standards; the standards are bound incompletely and/or incorrectly to rank the accounting alternatives – thus leading to an incorrect or undefined accounting specification. This section emphasizes this impossibility result. Bradshaw et al. (2004) note that practitioner surveys provide anecdotal evidence of their preferences. Gavin, Anderson, and Company, an international investor relations consulting firm, interviewed 48 U.S. portfolio managers, analysts, and research associates from 37 institutions regarding factors that influence international investment. Every investor polled stated that U.S. GAAP is very important or important in making investment decisions (Bank of New York 2003). Similarly, McKinsey’s (2002) survey of factors affecting international investment stated that 90% of global investors surveyed would prefer one set of global standards. Among North American respondents, 76% favored GAAP as this standard. It is interesting that, although 59% of Latin American respondents favored U.S. GAAP, 78% of Western European and 65% of Asian respondents favored IAS. Similarly, a KPMG (2000) survey of European firms found that their assessment of the quality of IAS and U.S. GAAP depended on the type of GAAP they employ. Overall, the survey evidence suggests that respondents are more favorably inclined toward the GAAP they have adopted – that is, home bias. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.15 Government procurement Trionfetti (2000) uses OECD data and estimates that contestable government procurement markets account for 7% to 9% of GDP in developed countries. Thus, the state has considerable influence over the allocation of resources in market economies through procurement. A prominent aspect of such procurement is the preference for domestic over foreign firms in the award of public contracts despite cost and quality considerations. This home bias in public purchase decisions has nontrivial efficiency effects. A home bias can reduce trade flows and influence international specialization, especially in sectors where public demand is large relative to domestic output, and which are characterized by monopolistic competition and increasing returns to scale (Trionfetti, 2000). Factual evidence in support of this home bias has been provided in the literature. One branch of the literature (procurement) has evolved to explain this home bias in public procurement under alternative assumptions of domestic and foreign firm cost distributions and attributes of the government’s objective function. Another branch of the literature (political economy) has looked at corruption and bribery as determinants of this home bias. Finally, still another branch of the literature (trade macroeconomics) has studied the consequences of a procurement home bias on trade and specialization.19 The procurement literature has developed models showing that discrimination may be necessary to minimize average procurement costs. McAfee and

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McMillan (1989) consider one such case with asymmetric and lower foreign firm costs and a low number of bidders, both domestic and foreign. They show that in such situations, foreign firms may exploit their cost advantage by bidding just below the expected domestic firm bid and hence, discriminating against them may be welfare enhancing. Even when costs are assumed to be symmetric and the social costs of distortionary taxation are accounted for, Branco (1994) has shown that insofar as foreign firm profits do not enter the government’s objective function, it will be optimal for the government to prefer domestic suppliers. However, unlike in McAfee and McMillan (1989), where a home bias only results in foreign firms lowering their bids, in Branco (1994), a home bias results in home purchases. A review of this theoretical literature, thus, suggests that domestic-foreign cost differentials and attributes of the government’s objective function have a bearing on the choice of suppliers. Other evidence discussed in some detail by Evenett and Hoekman (2004) suggests that the preference for domestic suppliers may be driven by a range of procurement-specific and domestic policy factors. These include the nature of the good or service being procured, the value of the procurement contract, the extent of domestic competition, practical considerations of the tender, compliance costs, regulatory burden, and the domestic policy environment. Governments are also saddled with other objectives, owing to which the award of contracts is not always governed by efficiency considerations, further embedding discrimination in procurement. For instance, governments may need to use procurement as a tool of aggregate demand management to stimulate Keynesian multiplier effects in an economy. Procurement home bias has been documented in major economies during the recent economic crisis (Evenett, 2009a, 2009b) which suggests that the propensity to spend at home may be stronger during recessions. There are several variables, which are used commonly in the trade and growth literatures, that can serve as reasonable proxies for such determinants – e.g., GDP growth, unemployment rates, and real exchange rates. In fact, changes in the latter may influence the choice of suppliers both directly (a stronger currency also makes public imports less expensive) and indirectly (by influencing foreign firms’ participation decisions – Baldwin 1988; Baldwin and Krugman 1989; Campa 2004; and via changes in firm mark-ups – Berman et al. 2012). A change in procurement metrics can also be dictated by political economy compulsions such as governments being in an election cycle. The impact of political institutions on economic policy has been studied extensively in the political budget cycles literature (see Alesina et al. 1997 for a review). This body of literature explores the implications of electoral cycles on the size and composition of government spending to conclude that governments increase spending before elections to enhance their chances of re-election. In keeping with the endogenous protection literature as well (e.g., Grossman and Helpman 1994), governments are more likely to award contracts to domestic firms during electoral cycles, since this would improve their chances of being re-elected. This is also consistent with findings in more recent procurement literature that looks at the effect of political connections on the allocation of procurement contracts

160 A place-attachment explanation (Goldman et al. 2010; Hyytinen et al. 2011) and the effect of the tenure in office on public procurement (Coviello and Gagliarducci 2017). Thus, a home bias is likely to be accentuated during or before an election period. In the trade macroeconomics literature, Baldwin and Richardson (1972) have shown that in a partial equilibrium perfectly competitive framework, when imported and domestic goods are perfect substitutes and when government demand for these goods is a fraction of domestic output, then a reduction in imports from the government is compensated by a corresponding increase in the imports of the private sector. Thus, the effect of a home bias in procurement on domestic output and imports is “neutralized” and discriminatory public procurement is rendered ineffective as a protectionist device. Miyagiwa (1991) has extended this result to an oligopolistic set-up showing that the “crucial assumption” for the “neutrality proposition” (term coined by Brulhart and Trionfetti 2004) has been perfect substitutability between imported and domestic goods. He has also shown the result to be less clearcut for differentiated goods. Finally, Trionfetti (2001) and Brulhart and Trionfetti (2004) have examined the result in monopolistic competitive markets and have found home-biased procurement to increase domestic output and reduce imports, regardless of the size of public demand relative to domestic output. Finally, international disciplines on procurement, such as the World Trade Organization (WTO)’s plurilateral Agreement on Government Procurement, are expected to discourage a home bias in public purchase decisions by eliminating discrimination against foreign products and suppliers – through their provisions on transparency; by requiring their signatories to ensure greater contestability of their public markets; and by ensuring more effective enforcement (e.g., Mattoo 1996, 1997). The study by Francois et al. (1997) compares public and private demand across 85 U.S. industrial sectors and infers the ineffectiveness of home bias from the “smallness” of public demand. Using EU data, Brulhart and Trionfetti (2001, 2004) also show that procurement home bias matters for industrial location/specialization. Shingal’s (2015) empirical results with respect to Japan and Switzerland support the Baldwin–Richardson–Miyagiwa–Brulhart–Trionfetti theoretical predictions and find evidence for the adverse effects of a procurement home bias in monopolistic competitive sectors, thus providing more support to the evidence in this literature (Trionfetti, 2000) on the impact of discriminatory procurement on trade flows and international specialization. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.16 Academic research citations In order to have a better grasp of the pattern of academic research citations it would be beneficial to consider the contributions in the field of bibliometrics – which indicate geographic bias in the scientific community’s citation patterns; and in the field of the sociology of science – which emphasizes the notions of paradigms and scientific communities.20

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3.16.1 Bibliometrics and geographic distance Bibliometrics, among other things, studies the social networks of citations found in articles, and thus provides useful insights. Bibliometrics has been used to empirically test the hypothesis that geographic distance is an explanatory variable for academic research citation patterns. Evans et al. (2011) conclude that geographic proximity is the determining factor in collaboration between scholars, that is, they are more likely to work with those who are nearest. Their results corroborate an earlier study by Cummings and Kiesler (2007) that show the greater the distance, the harder it is to communicate and make decisions on research projects. There is also the rule of thumb proposed by Allen (1977) suggesting that collaborators should not be further than 30 yards away; and Kraut et al. (1990) who note that the greater the distance, the greater the adverse impact on collaboration effectiveness. However, nowadays, the use of the internet in research is expected to influence not only the amount of research output, but also the way research is managed and coordinated, especially in distributed research teams (Heimeriks and Vasileiadou 2008). Mahlck and Persson (2000) highlight the importance of academic departments as knowledge creators, showing that there is a large body of internal citations within a given academic department, most of which focus on its main researchers. Furthermore, the likelihood of self-citations rises as a research group pursues its own lines of research. In other words, there is empirical evidence of the reciprocity of citations within departments, given that a large volume of citations bears on the work carried out by other members of the faculty. Correspondingly, there is a lower propensity to cite external studies. Clements and Wang (2003) come up with similar results in their study on the likelihood that Ph.D. students cite their supervisors. After examining behavior in eight Australian universities, they find that students are more likely to cite their supervisors or members of their department than members of similar departments in other universities. Furthermore, as in economics and finance literature, there is empirical evidence that geographic proximity plays a key role in citation behavior. For example, the country in which an author conducts his or her research has its own scientific tradition. Here, there is frequent mention of the gap between American and European research traditions (McWilliams et al. 2009). The same applies to countries which fell within either the former Soviet bloc or the Western bloc (Inonu 2003). Sjoberg (2000) reveals the difficulties encountered by European researchers in being cited by American scientists if they had not published in U.S. journals. Marsden and Friedkin (1994) show that proximity helps explain behavior in social networks. They argue that proximity may be cultural and/or geographic. 3.16.2 The sociology of science and the home nature of the scientific community In order to find an explanation for geographically based arguments, it is necessary to consider Kuhn’s (1962, 1972) notion of paradigm and scientific community. The argument for an inter-related scientific benchmark community – as per Kuhn

162 A place-attachment explanation (1962, 1972) – was strengthened by the results of the studies conducted by Johnson and Oppenheim (2007). Their studies apply social network analysis to citation structures in published papers, and reveal a positive correlation between social proximity between authors and citation of their works. These authors concluded that friends are more likely to cite one another than to cite others. White et al. (2004) state that while there are social links, scholars’ bias in favor of citing others they know may stem from intellectual affinity rather than friendship. Both results, though apparently different, make sense when looked at from the standpoint of the same scientific community or research program. Thus, favorable citation bias coincides with friendship and/or intellectual affinity because both occur naturally within any given research community. The notion of community is also discussed in studies by Evans et al. (2011) and Fortunato (2010). The latter authors note that a given scholar becomes a member of a community when his/her links to this community are stronger than they are to other communities. However, they also note that not all members of a given community know each other directly. In many cases, the links are indirect – that is to say, through other members of the community. The result is a group of scholars who know one another, whether directly or indirectly, which can be envisioned as a home research community. Home bias can be regarded as arising from the bias that perhaps exists in such a home community. Hence, the importance of understanding the community’s paradigm and the language it uses. A scientific community shares not only the same language, but also models, propositions, and methodologies (which may or may not be “home-grown”). From the bibliometrics standpoint, the hypothesis is supported by evidence that geographic proximity is reflected in the citation patterns followed in a given community, which is engaged in empire-building against other communities. It therefore makes sense to speak of home bias, as can be deduced by the concept of a negative heuristic raised by Lakatos (1971). As noted above, home research communities exist and rest mainly on geographic proximity, which at the very least operates on the national scale. In this respect, and drawing upon some of the features described by Kuhn (1962, 1972) in describing institutionalized scientific communities, it is necessary to mention the research published in 2004 by the Journal of Management Inquiry, which studied the extent to which business education was Americanized in the following countries: England (Tiratsoo 2004); Germany (Kieser 2004); France, Italy, Spain, and Turkey (Kipping et al. 2004); and Sweden, Denmark, Norway, and Finland (Engwall 2004). The impact of the American business school model was analyzed in all these countries, based on historical reconstruction of the birth of business studies in each nation, as well as the institutions, journals, societies, universities, and schools that sprang up as a result. These publications reveal the existence of local scientific communities at the national level. These communities may constitute a home benchmark for researchers and, thus, give rise to the home bias in citations within a given community.

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A country might be considered as a unifying element for an academic institution with its own special features. Studies that seem to confirm this are Lange’s (1985) – mentioned above – and Greeson’s (1991), which reveal that for many years, the U.S. did not consider scientific contributions made by the Scandinavian scientific community in psychology. In addition, studies by Byrkjeflot (2001), Engwall (2007), and Evans et al. (2011) have taken nations as the unit for their research. Correa, Gonzalez-Sabate, and Serrano (2013) follow the research approach employed by Lange (1985), who identifies possible home bias in various countries on studying 30 papers published between 1977 and 1981 in 15 academic journals published in the U.S., U.S.S.R., Poland, Federal Republic of Germany (West Germany), and German Democratic Republic (East Germany). Correa et al. (2013) make a new contribution to the literature insofar as they validate Lange’s (1985) findings in a context that has changed greatly from that of 1985 in social, political, economic, and technological terms. Lange’s (1985) study was conducted at the end of the Cold War. At that time, citations, the languages in which papers were published, and their geographic dissemination were all conditioned by a world split into two blocs. The world is very different now: Databases can be accessed over the internet from any corner of the world, scholars can move freely from one country to another, publish their papers in other languages and foreign journals, attend international congresses, and so forth. This new setting is a complete break with the Cold War bloc structure, the context in which Lange (1985) carried out his study. That means that if there is home bias, other reasons must be sought to explain it. Correa et al. (2013) examine the possible home bias in the citation of the 300 most cited articles in selected management journals between 2005 and 2009. The management journals chosen for the study were the ten with the greatest average impact over the past five years. The data from the sample provide empirical evidence of a home bias in the citation pattern of the papers analyzed. In summary: (1) Bibliometrics reveals the geographic dimension in citation patterns; (2) the sociology of science delimits this geographic dimension to the benchmark scientific community which can be related to a given country in most cases; and (3) there is empirical support for the phenomenon of home bias in the research citations of academic communities. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.17 Patent citations Since the early 1990s, a large body of macroeconomic research has underlined the relationship between knowledge spillovers and aggregate economic growth. Many knowledge-driven macroeconomic models draw attention to different economic growth rates that result from different types of knowledge flows.21 The nature and scope of knowledge spillovers play prominent roles in determining the equilibrium path of economic growth, and patent citations are

164 A place-attachment explanation increasingly used to explore knowledge flows across regions, countries, and technologies. Patent citations are also increasingly used to track knowledge flows between different applicants or inventors and to assess the intensity of knowledge spillovers and their geographic and technological scope. Patents are the manifestation of inventive activity covering virtually every field of innovation. Patent citations are the references to patents appearing in the patent documents themselves. When an invention patent is issued by government patent offices, its text normally includes citations to prior patents (and also to relevant prior scientific and technological literature). To be patentable, an invention must be novel, that is, not anticipated in the already practiced state of the art. Citations placed in the patent text, usually by either the inventor’s attorneys or by patent office examiners (depending upon national practice), serve to show how the claimed invention differs from the “prior art” and hence to help stake out the metes and bounds of the new claims. In a sense, citations identify the shoulders upon which the new claims stand in their attempt to advance technology. In patent documents, citations are used by examiners and applicants to show the degree of novelty and inventive steps of the patent claims. They are located in the patent text, usually either by the inventor’s attorneys or by patent office examiners. Once published, they provide a legal delimitation of the scope of the property right. Therefore, citations identify the antecedents upon which the invention stands and, for this reason, they are increasingly used in economic research to gauge the intensity and geographic extent of knowledge spillovers and to measure the economic value of innovations (Griliches 1990). Typically, citations from both United States Patent and Trademark Office (USPTO) and European Patent Office (EPO) patents are used in economic analysis. The use of patent citations as an index of knowledge flow has been validated by Jaffe et al. (2000) for the USPTO (with a survey of inventors) and by Duguet and MacGarvie (2005) for the EPO (with Community Innovation Survey data). Jaffe et al. (1993), Malerba and Montobbio (2003), Malerba et al. (2013), Maruseth and Verspagen (2002), and Verspagen (1997) provide evidence on the nature and types of knowledge spillovers using patent citations. Most of the recent literature that identifies knowledge spillovers in geographic space using patent data has followed the approach proposed later by Jaffe et al. (1993). Exploiting the fact that each patent refers to a number of previous patents as sources of relevant information, Jaffe et al. (1993), and later other researchers (e.g., Maurseth and Verspagen 2002 for European regions and Sjoholm 1996 for Sweden), have used such a paper trail to track the direction and extent of spillovers. Most articles use patents and patent citations. Griliches (1990) provides a path-breaking and renowned survey, and OECD (1994) is a highly referenced manual. A set of important papers from the National Bureau of Economic Research (NBER) group is collected together in Jaffe and Trajtenberg (2002). Hall et al. (2005), Harhoff et al. (1999), Lanjouw and Schankerman (2004), and Trajtenberg (1990) are fundamental references on patent citations and the value

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of innovations. On patent citations and knowledge spillovers, there is a useful survey by Breschi et al. (2005). Many papers show that patent citations tend to be geographically localized (Bottazzi and Peri 2003; Breschi and Lissoni 2009; Criscuolo and Verspagen 2008; Jaffe et al. 1993; Jaffe and Trajtenberg 1999; Maruseth and Verspagen 2002; Peri 2005). In particular, Jaffe and Trajtenberg (1999) analyze patent citations at the USPTO and show the existence of a home bias in USPTO patent citations. In other words, an inventor from one country is much more likely to cite other inventors from the same country compared with inventors from other countries; this is especially true for American inventors. Bacchiocchi and Montobbio (2010) also use patent citations to estimate the process of international diffusion and obsolescence of technical knowledge by countries and technological fields. They ask whether the result obtained by Jaffe and Trajtenberg (1999) is generated by the specific organizational characteristics of the USPTO, or rather reflect true phenomena. Therefore, their empirical exercise is based on the comparison of results from the USPTO and the EPO, using new and more recent data to confirm some of the results obtained by Jaffe and Trajtenberg (1996, 1999) and Hall et al. (2001). In particular, they find a strong localization effect at country level at the EPO, and the size is comparable to that found at the USPTO. This eliminates the doubt that the Jaffe and Trajtenberg results – obtained solely with USPTO data – may depend on biases in the U.S. examination and patent search procedures. Considerable evidence shows that patent citations tend to be localized. The classic reference is Jaffe et al. (1993). They show that citing patents are up to three times more likely than control patents to come from the same state as the cited ones, and up to six times more likely to come from the same metropolitan area. Using the NBER-USPTO data, Jaffe and Trajtenberg (1999) show that patents from the same country are 30% to 80% more likely to cite each other than patents from other countries. In the same vein, Peri (2005) shows that knowledge flows tend to be geographically localized. He also uses NBER data on patents and patent citations from the USPTO, for a panel of 113 European and North American regions over 22 years. Turning EPO citations, Maruseth and Verspagen (2002) use a cross-section of 112 European regions to show that EPO patent citations are geographically localized. Similar results, also using EPO citations, are obtained by Bottazzi and Peri (2003). Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.18 Entrepreneurship Obschonka et al. (2018a) note that the economic impact of regional and local cultural characteristics has received steadily increasing attention over the past two decades (Duranton, Rodriguez-Pose, and Sandall 2009; Greif and Tabellini 2010; Guiso, Sapienza, and Zingales 2004b). This attention has, according to Huggins and Thompson (2019), spurred an interest in new measures and

166 A place-attachment explanation aspects of culture taken from psychological research, such as regional personality differences (Hofstede and McCrae 2004; McCrae 2004; Rentfrow et al. 2013) and in how personality differences in the cultural make-up of territories affect regional economic trajectories (Lee 2017; Obschonka et al. 2018b). Obschonka, et al. (2018a) further note that one example where geographic cultural patterns can play a particularly important role for economic outcomes is the field of entrepreneurship (Fritsch and Wyrwich, 2014). The analysis of local or regional psychological differences has become an important subject of entrepreneurship research (Davidsson 1995; Davidsson and Wiklund 1997; McClelland 1961; Saxenian 1994). Consistent with theorizing on the central role of culture for regional entrepreneurship (e.g., Hayton, George, and Zahra 2002; Sternberg 2009), this literature has shown that a cultural perspective helps explain spatial variations in entrepreneurship. The debate about what entrepreneurial culture actually is and how we measure it is, however, ongoing (Hayton and Cacciotti 2013). Earlier studies focused on values, beliefs, and need for achievement – often with inconsistent findings (Hayton and Cacciotti 2013). More recent research has delved into the spatial effects of the Big Five personality traits, often by building entrepreneurial personality profiles from constellation of these traits. The Big Five model is the most established and best-validated trait model in psychology (Digman 1990; John and Srivastava 1999) and has received considerable attention in entrepreneurship research in recent years (Brandstatter 2011; Shane et al. 2010; Zhao, Seibert, and Lumpkin 2010). The Big Five traits have gradually become a more common indicator of the psychological facet of the local culture (McCrae 2004). The entrepreneurial personality profile most associated with local entrepreneurship includes high values in extraversion, conscientiousness, and openness to experience; and lower values in agreeableness and neuroticism (Audretsch et al. 2017; Fritsch et al. 2018; Garretsen et al. 2018; Obschonka et al. 2013, 2015, 2016; Stuetzer et al. 2018). The study performed by Obschonka, et al. (2018a) pushes forward the entrepreneurship research studying the role of personality (Brandstatter 2011) and regional psychological characteristics (Audretsch et al. 2017; Davidsson and Wiklund 1997; Huggins and Thompson 2019) by using Big Data methods (Zomaya and Sakr 2017). Their study supports the growing evidence that geographic changes in personality shape economic (and other) outcomes of regions (Garretsen et al. 2018; Glaeser, Kerr, and Kerr 2015; Lee 2017; McClelland 1961; Obschonka et al. 2016; Stuetzer et al. 2018), and also favors the literature that examines how economic factors, in turn, affect regional personality differences (Obschonka et al. 2018b). Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.19 Entrepreneur location choice Dahl and Sorenson (2012) point out the following facts. Entrepreneurs tend to start their businesses in the regions in which they have deep roots, the places where they have family and friends, their home regions (e.g., Katona and

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Morgan 1952, Mueller and Morgan 1962). They are even more biased toward remaining in these places than employees (Dahl and Sorenson 2009, 2010; Michelacci and Silva 2007). Yet, home regions often offer less favorable economic environments for their start-ups than other possible places (Figueiredo et al. 2002; Sorenson and Audia 2000). Together, these facts pose a puzzle: Entrepreneurs, who have much to gain or lose from their location choices, remain rooted in their home regions, even when more favorable conditions exist elsewhere.22 Dahl and Sorenson (2012) used data from Demark, and operationalized regional attachment in terms of the number of years that an entrepreneur had lived in a region prior to founding his or her firm, and found that the entrepreneurs with longer tenure in a region had businesses that survived longer and that generated greater annual profits. Parwada (2008) notes that, beginning with French and Poterba (1991), a growing literature documents strong links between investors’ portfolio decisions and geographic location. The phenomenon is reported for individual investors (Grinblatt and Keloharju 2001; Huberman 2001; Lewis 1995, 1999) as well as important intermediaries such as mutual funds (Coval and Moskowitz 1999, 2001; Hong et al. 2005; Ivkovic´ and Weisbenner 2005). The role of geography in economic activities has continued unabated despite phenomenal strides in information technology and the attendant reduction in transportation and communication costs (see Coval and Moskowitz 1999, p. 2047). While a significant literature addresses the consequences of location-based factors on outcomes such as the investment performance of portfolio managers, the origins of the location choices are not fully understood. Moreover, virtually no research has targeted relations between the characteristics of investment companies’ location choices and the geographic spread of their portfolio holdings. In his paper, Parwada (2008) attempts to fill this gap by examining the location decisions of fund managers who start their own investment management firms. He also examines how fund managers’ stock holdings relate to their former and newly chosen locations. Specifically, he addresses two main research questions: (1) Which location characteristics attract investment management start-ups?; (2) Do entrepreneurs tilt their portfolio holdings toward stocks that are close to where they locate? Parwada (2008) traces the employment and geographic heritage of 358 entrepreneurial fund managers and analyzes the determinants of where they locate their firms and stock selections. The evidence suggests that start-ups tend to be based close to the origins of their founders and in regions with more investment management firms, banking establishments, and large institutional money managers. High payroll costs are not a deterrent to location, but factors inimical to managers’ personal social and economic affluence, such as poor education and employment prospects, drive away start-ups. Parwada (2008) finds that a clear home bias exists in the location decisions of entrepreneurial fund managers. Over 75% of entrepreneurial fund managers locate within 25 kilometers of

168 A place-attachment explanation their former employers’ regions. These statistics suggest that most entrepreneurial fund managers are constrained to their original location by such considerations as the need to perpetuate professional, social, and family networks, and relocation costs. Controlling specifically for start-ups whose founders mostly originate from the same area as the new firm, Parwada (2008) confirms that the area of origin heavily conditions where founders locate. Parwada (2008) finds that new money managers show a strong local bias in their equity holdings, three times the levels previously documented for mutual funds. The propensity to invest closer to home correlates strongly with the presence of sub-advisory opportunities from institutional investors in the vicinity. While home bias levels between managers who relocate with their start-ups and the rest of the entrepreneurs are similar, preferences for stocks that were formally local persist. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.20 Forum selection in law The issue of forum selection in international or intranational business contracts arises because international business contracts or multi-state transactions within federally structured countries might be subject to more than one sovereign adjudication system. In case of conflict between the transacting parties, the appropriate tribunal must be identified. The multinational (or multi-state) nature of the deal usually allows for several competent national courts. Private international law rules determine which of the involved countries’ courts has jurisdiction. However, the transacting parties might opt to contract, either ex ante or ex post, and choose the forum(s) that will adjudicate potential disputes. Business practice consistently shows a clear preference to select the home court and legal system to settle international business disputes. The notion of a home court advantage seems to be accepted in the literature.23 Since the beginning of the 1970s, scholars have been treating litigation considerations like other business issues. That is, firms base their decisions upon the perceived economic gains from the litigation decision. In this respect, litigation decisions could be treated as an investment decision. This may be true at any stage when a firm has to contemplate a litigation strategy. In this way, scholars have been applying an investment model to the analysis of various litigation-related decisions. Such decisions may take place prior to the litigation, or at an early stage of the litigation (Gould 1973; Landes 1971; Posner 1973), or even at an advanced stage of an ongoing litigation (Cornell 1990). The investment model (the portfolio model) of litigation has been used for understanding litigation-related decisions in view of the uncertainty (risk) inherent in the judicial process, and the conclusion is that parties must diversify their forums. In contrast, what they observe in practice is home bias.

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The parties might choose a court in one party’s home country or state, or alternatively, a “neutral” forum in another country. In reality, businesses consistently prefer their home court. This is especially true for firms that export products or services to many other jurisdictions (e.g., Brenner 1997; Faruki 1985; Park 1998; Vairo 1998). Of course, both parties to an international business contract cannot choose the home court; it is the “stronger” party that “wins” this privilege. Home court advantage is the core of forum non-convenience litigation. Despite the similarity to forum selection clauses in the cases where both parties opt for the home court, the two are quite different. In the context of forum non-convenience litigation, the parties are acting to maximize their wealth ex post, and actually redistributing the wealth allocation as per the original transaction (in the contractual context). In contrast, in the context of forum selection clauses, the allocation is made ex ante, and each party calculates the advantages of the home court in the contract price. Allowing forum non-convenience litigation into fair business-to-business transactions will actually increase transaction costs, since ex post parties are trying to obtain more wealth out of the contract by re-shifting prior allocation to their counterpart. This is probably why forum selection clauses are so popular. Following are some stylized facts, examples, and anecdotal evidence for the overwhelming corporate preference for the home court. The World Bank has forum selection clauses (New York, U.S.A.) in its contracts. Microsoft has a forum selection clause (King County, Washington, U.S.A.) in its click-wrap member agreement for The Microsoft Network. A decision in the Superior Court of New Jersey, U.S.A. (dated October 16, 2003) states, “Forum selection clauses are common components of international commercial transactions.” Lyon and Ackerman (2002) state that forum selection clauses “increasingly are included in construction contracts.” Venture Capital firms that finance international projects have forum selection clauses. Various theoretical explanations for the home court advantage include (1) transaction costs, (2) impartiality of forums, (3) moral hazard (agency problem), (4) knowledge of the probability distributions of foreign courts, (5) specialization, and (6) home bias. Bhattacharya, Gaplin, and Haslem (2007) empirically use a comprehensive sample of 2,361 public U.S. corporate defendants and 715 public foreign corporate defendants in U.S. federal courts in the period 1995–2000, and find that the market reaction at the announcement of a U.S. federal lawsuit is less negative for U.S. corporate defendants than for foreign corporate defendants. They find that U.S. firms are less likely to lose than are foreign firms when they control for year, industry, type of litigation, size, profitability, and sample selection bias. They, thus, cannot rule out that U.S. firms have a home court advantage in U.S. federal courts, that is, foreign firms are disadvantaged in U.S. courts. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

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3.21 Real estate Badarinza, Ramadorai, and Shimizu (2018) document a new “nationality bias” which impedes the efficient functioning of global markets for commercial real estate. In a large and comprehensive database of global commercial real estate transactions, Badarinza et al. (2018) find that buyers are significantly more likely to purchase properties from sellers with the same nationality. This preference to transact with the same nationality is quantitatively large and robust. Badarinza et al. (2018) note that an important precondition for economic transactions to occur is comfort with one’s counter-party, and with the market in which these transactions occur. Discomfort caused by the mistrust of the counter-party or the environment, ambiguity aversion, or concerns about asymmetric information have been linked to suboptimal financial decisions and biases in a wide variety of economic contexts. Notable examples include home bias at home and abroad arising from concerns about asymmetric information or preferences for familiarity,24 mistrust leading to non-participation in the stock market,25 ambiguity aversion leading to overinvestment in own-company stock,26 and loyalty-based portfolio choice.27 In their paper, Badarinza et al. (2018) discover a new and important bias of this kind. They show that in commercial real estate markets, an important venue for both local and cross-border investment (with global transaction volume of US$ 660 billion in 2016), buyers of properties have an unusually strong tendency to transact with sellers who hail from their country of origin.28 They term this pronounced preference to transact with those from the same country “nationality bias,” and find that it is both large and robust using a comprehensive database of global commercial property transactions from 2007 to 2017. Badarinza et al. (2018) state that in recent years, the market for commercial property has turned truly global. In both developed and developing countries, it is not uncommon for the most prestigious parcels of office real estate, hotels, or landmark cultural facilities to be owned, operated, or redeveloped by international investors, with a significant impact on urban transformation, market liquidity, and the affordability of rental space. If this important market were operating efficiently, transactions should be motivated purely by calculations of risk-adjusted return, and capital would flow towards properties solely on the basis of such rational calculations. Badarinza et al. (2018), therefore, begin with the simple null hypothesis that there should be no systematic preferential matching in these markets between buyers and sellers based on their country of domicile. If this null hypothesis were true, then the fraction of all transactions involving sellers from a particular country (the benchmark) would be exactly the same as the fraction of sellers in transactions which involve buyers from the same country. Alternatively, if buyers from a particular country prefer to purchase properties from sellers with the same nationality, there would be a systematic bias, with the fraction of sellers in transactions with same-country buyers being far higher. An example

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may make this clearer: Consider a specific region of the world in which commercial property transactions occur, and assume that Indian sellers account for one-tenth of these transactions, regardless of the nationality of buyers. Under the null of no nationality bias, Indian sellers should also constitute a tenth of all transactions conducted by Indian buyers. If the representation of Indian sellers in transactions involving Indian buyers was far greater than a tenth, one would conclude that there is a systematic preference for Indian buyers to transact with sellers hailing from their own country. In their empirical analysis, Badarinza et al. (2018) use a novel dataset of transaction-level information from Real Capital Analytics, which covers transactions in 70 countries over the period between January 2007 and October 2017, and aims to cover the universe of global commercial real estate deals worth more than US$10 million. For the over 120,000 properties transacted over this period, Badarinza et al. (2018) have access to a number of details about the buyers and the sellers, including the name of the companies involved, and the country in which they are incorporated. On this basis, Badarinza et al. (2018) classify each transaction in terms of the matching of buyer and seller nationalities, distinguishing between situations in which buyers and sellers of the same nationality match with one another at home – a French buyer purchasing the property from a French seller in Paris; or abroad – a Chinese buyer trading with a Chinese seller in London. In these data, when buyers transact at home, they are on average 2% more likely to match with sellers of their own country relative to the benchmark seller distribution. However, when they transact abroad, the corresponding increase in the propensity to match with sellers of their own country is a substantial 44% of the unconditional fraction of sellers from foreign countries, that is, nationality bias is far stronger abroad than it is at home. Badarinza et al. (2018) also find that the prices of transactions involving buyers and sellers from the same country are higher on average by 7.36%, controlling for a range of hedonic characteristics, time, and region effects. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

3.22 Sport competition Research has established that there is home advantage – wherein a team is more likely to win, and by a larger margin, when they are playing at home vs. away – in sports29 such as soccer, baseball, ice hockey, basketball, American football, Australian football, cricket, figure skating, speed skating, alpine skiing, freestyle skiing, ski jumping, tennis, golf, boxing, gymnastics, and cross-country running (Carron et al. 2005; Courneya and Carron 1992; Nevill and Holder 1999; Schlenker et al. 1995). Several explanations for home advantage have been advanced, some of which suggest that the actions of fans interfere with player communication on the away team, increase the motivation of the home team, intimidate the away

172 A place-attachment explanation team into making errors, cause the away team to exert less effort, and intimidate referees into calling more (fewer) penalties against the away (home) team (Courneya and Carron 1992; Greer 1983; Schlenker et al. 1995; Thirer and Rampey 1979). Running through many of these explanations is the idea that fans, as loyal customers of the home team, directly influence the likelihood of victory, and that team management can influence the extent of home advantage by promoting certain kinds of fan behaviors (Downward and Jones 2007; Nevill et al. 2002; Zeller and Jurkovac 1989). Though all these explanations seem plausible, many are difficult to test empirically because they involve monitoring the psychological states of athletes during the competition, which is usually not possible (Polman et al. 2007; Terry et al. 1998). The exception is the biased officiating explanation, since records of referee decisions are kept on record and can be examined well after the competition has ended. The evidence that referees call more penalties against away teams is abundant (Carron et al. 2005). Research on soccer, Australian Rules football and other rugby competitions provides some indication of the nature and extent of biased officiating in favor of the home team. Nevill et al. (1996) reported that home teams were awarded significantly more penalties in English and Scottish soccer matches. Similarly, Boyko et al. (2007) and Dawson et al. (2007) found that referees in the English Premier League awarded more penalty kicks and assigned fewer yellow and red cards to home teams. Sutter and Kocher (2004) found that referees added more second-half injury time when the home team was behind compared with when it was ahead, and awarded more penalties to home teams in the German Bundesliga soccer competition. Additional research establishes more explicit links between fan behavior, biased officiating, and home advantage. Page and Page (2010) found a relationship between crowd size, the extent of officiating bias, and the size of home advantage in an analysis of 37,830 soccer matches. Garicano et al. (2005) showed that referee bias and the extent of the home advantage increased with the size of the crowd and the proportion of the crowd favoring the home team. Dohmen (2008) linked referee bias to the physical proximity of the crowd to the actual playing field, suggesting once again that crowd noise plays a major role in biasing referees’ decisions in favor of the home team, and hence, in creating home advantage. However, Nevill et al. (2002) provide perhaps the most definitive evidence of the role of the crowd in referee bias. They showed films of several potential fouls committed in soccer matches to actual referees and asked them how they would have ruled without showing them the decision of the match referee. When the videotape included an audio track of the home fans’ reaction, the participants tended to agree with the match official, and displayed a bias in favor of the home team. But, when the audio track was deleted, their decisions deviated from those of the match referee, and the home bias was eliminated. Hence, crowd noise seems to be an important influence on home advantage, in part because it biases referees’ decisions in favor of the home team.

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Page and Page (2011) examined referee bias in club-level rugby union and rugby league competitions involving teams and referees from multiple countries. They found that referees favored teams from their own country over teams from other countries in terms of total penalties, penalty kicks, scrum feeds, yellow cards, red cards, and verification of tries. More importantly, their research identified a number of situations wherein biased officiating is likely, including close matches (see also Dohmen 2008; Garicano et al. 2005; Sutter and Kocher 2004), decisions not recorded as official match statistics, decisions not subject to scrutiny by television or stadium video replay, and matches where the favored team is behind, and suggests that the home advantage is due, in part, to biased officiating (see also Dawson et al. 2007; Page and Page 2010). Areni (2014) examines representative rugby competitions involving teams comprised of “all-star” players from several clubs. He finds that significant home advantage exists in both competitions, and within Tri Nations, the size of the effect varies by team and specific opponent (i.e., rivalry effects). Although there is evidence of referee bias in favor of the home team, the penalty differential between the home and away teams does not mediate home advantage. Mohr and Larsen (1998) found that Australian Football League teams originating in the same state as the umpire were awarded more free kicks per game than teams from different states. More specifically, over the four years 1992–1995, Mohr and Larsen (1998) examined the results of Australian Football League matches between a Victorian and non-Victorian team where all umpires were from Victoria. Mohr and Larsen (1998) suggest that the circumstances in which referees are most likely to be suspected of biased judgments are those in which they share a national or regional identity with one of the parties to a contest. The results presented by Mohr and Larsen (1998) confirm their “community” argument; that is, the Victorian teams received significantly more free kicks than the non-Victorian teams, with the advantage being substantially greater for games played in Victoria compared with those played outside Victoria. The above evidence is important because much of the research on home advantage examines sports competitions where the home fans’ affiliation with the team stems from membership in a small community, city, or university, and group affiliation is central to the fan behaviors that create home advantage (Gibson et al. 2002). The affiliation with other fans can, over time, come to feel like a surrogate family, with new partners, children, close friends, and other “family” members brought into the fold over time (Gibson et al. 2002), suggesting that home advantage may be more relevant when the team affiliation is local and community-based rather than statewide or national, where fans have less of a sense of community with one another. Place attachment can be seen to have contributed to the above-noted behavioral pattern.

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Notes 1 This section is based on Huberman 2001. 2 This section is based on Pradkhan (2016) and Sercu and Vanpee (2007). 3 For example, Hong and Kacperczyk (2010) show that more analyst coverage for a given company results in better-quality analysis, while Merkley, Michaely, and Pacelli (2017) show that the level of coverage within the industry has a similar effect. 4 Studies discussing broker conflicts of interest include Barber, Lehavy, and Trueman (2007), Bradley, Jordan, and Ritter (2003), Firth et al. (2013), Lin and McNichols (1998), Ljungqvist et al. (2007), and Mola and Guidolin (2009). Studies focusing on career concerns include Hong and Kubik (2003) and Hong, Kubik, and Solomon (2000). 5 For this literature see Aharony and Swary (1996), Berger et al. (2003), Berger and DeYoung (2001, 2002), Buch (2005), Coval and Moskowitz (2001), Fuentelsaz and Gomez (2001), Grinblatt and Keloharju (2001), Grosse and Goldberg (1991), Hau (2001), Huberman (2001), Lerner (1995), Petersen and Rajan (2002), and Portes and Rey (2005). This section is based on Carey and Nini (2007), Degryse and Ongena (2005), and Mian (2006). 6 For this literature, see Apergis and Tsoumas (2009), Blecker (1997), Coakley, Kulasi, and Smith (1998), Feldstein (1994), Feldstein and Horioka (1980), Frankel (1992), Lapp (1996), Obstfeld (1995), Obstfeld and Rogoff (1996, 2000), Singh (2007), Tesar (1991), Zodrow (2010). This section is based on Apergis and Tsoumas (2009) and Coakley et al. (1998). 7 See also Chan, Covrig, and Ng (2005) and Pogano, Roell, and Zechner (2002). 8 See Collinson and Rugman (2008), Rugman and Girod (2003), and Rugman and Verbeke (2004). This section is based on Curran and Zignago (2012) and Guiso, Sapienza, and Zingales (2004a, 2004b). 9 For this literature see Anderson and Van Wincoop (2003), Frensch (2010), GilPareja et al. (2005), Hillberry and Hummels (2003), Li et al. (2016), Martens and Turlea (2012), McCallum (1995), Mourao (2011), Obstfeld and Rogoff (2001), Okubo (2004), Parsley and Wei (2001), and Wolf (2000). This section is based on Hillberry and Hummels (2003) and Li et al. (2016). 10 For the related literature in finance see Berriel and Bhattarai (2013), Heathcote and Perri (2013), Kollmann (2006), and Obstfeld (2006). For further literature in marketing see Acikdill et al. (2018), Shankarmahesh (2006), and Weber et al. (2018). This section is based on Balabanis and Diamantopoulos (2016) and Siamagka and Balabanis (2015). 11 See Baum and Sorenson (2003) for a survey. See also Audretsch and Feldman (1996), Degryse and Ongena (2005), Jaffe et al. (1993), Malloy (2005), and Petersen and Rajan (2002). 12 See Coval and Moskowitz (1999, 2001), Dvorak (2005), Feng and Seasholes (2004), Grinblatt and Keloharju (2001), Huberman (2001), Ivkovic´ and Weisbenner (2005), Pirinsky and Wang (2006), and Zhu (2002). 13 See also Hirshleifer and Png (1989), Milgrom (1981), and Milgrom and Weber (1982). 14 See, for example, Becker (1957), Breton (1964), Feiler (1935), Helleiner and Pickel (2005), Knight (1935), Olson (1987), Seers (1983), von Hayek (1937), von Mises ([1943] 1990). 15 See, for example, Burnell (1986) and Macesich (1985). 16 For studies on European mergers and acquisitions but without a political economy focus, see, for example, Bris and Cabolis (2008), Erel, Jang, and Weisbach (2012), Faccio and Masulis (2005), Ferreira, Massa, and Matos (2009), and Rossi and Volpin (2004). See Erel, Liao, and Weisbach (2012) for the determinants of cross-border mergers and acquisitions around the world.

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17 Loughran and Schultz (2005) examine the effect of a firm’s geographic location on liquidity and find that rural stocks attract less analyst coverage and observe less trading than do urban stocks. These results suggest that geographic location also affects liquidity. 18 For this literature see Alford et al. (1993), Armstrong et al. (2010), Ashbaugh and Davis-Friday (2002), Ball, Kothari, and Robin (2000), Bank of New York (2003), Barth, Clinch, and Shibano (1997), Barth, Landsman, and Lang (2008), Barth et al. (2012), Bartov et al. (2005), Bradshaw, Bushee, and Miller (2004), Bradshaw and Miller (2008), Dechow and Schrand (2004), Demski (1973), Dye and Sunder (2001), Eng, Sun, and Vichitsarawong (2014), FASB (1999), Frost and Pownall (2000), Glaum and Street (2003), Gordon, Jorgensen, and Linthicum (2011), Harris (1995), Harris, Lang, and Moeller (1994), Harris and Muller (1999), Hope (2003), Joos and Lang (1994), Kim, Li, and Li (2012), KPMG (2000), Krishnan (2003), Leuz (2003), Leuz and Verrecchia (2000), Lundholm and Myers (2002), McKinsey (2002), Sunder (2002), and Wall Street Journal (1999, 2002). This section is based on Bartov et al. (2005) and Demski (1973). 19 For this literature see Baldwin (1970, 1984), Baldwin and Richardson (1972), Branco (1994), Breton and Salmon (1996), Brulhart and Trionfetti (2001, 2004), Burguet and Che (2004), Burguet and Perry (2007), Chen (1995), Compte et al. (2005), Evenett and Hoekman (2005), Evenett and Shingal (2005), Francois et al. (1997), Hoekman and Mavroidis (1997), Laffont and Tirole (1991), Mastanduno (1991), McAfee and McMillan (1989), Miyagiwa (1991), Naegelen and Mougeot (1998), Rose-Ackerman (1975, 1978), Rothenberg (1993), Shingal (2011, 2015), European Commission (1997), Trionfetti (1997, 2000, 2001), Vagstad (1995), and Weichenrieder (2001). This section is based on Shingal (2015). 20 For this literature, see Hoekman, Frenken, and Tijssen (2010), Katz (1994), Luukkonen, Persson, and Sivertsen (1992), Newman (2004), and Sonnenwald (2007). This section is based on Correa, Gonzalez-Sabate, and Serrano (2013). 21 For this literature, see Griffith et al. (2003, 2004), Grossman and Helpman (1991), Piga and Vivarelli (2004), and Rivera-Batiz and Romer (1991). This section is based on Bacchiocchi and Montobbio (2010). 22 For this literature see Beugelsdijk et al. (2017), Dahl and Sorenson (2012), Filatotchev et al. (2007), Frenkel and Kaplan (2015), Gazaniol (2015), Hernandez (2014), Jain, Kothari, and Kumar (2016), Kang and Jiang (2012), Kuhlmann and Hutchings (2010), Parwada (2008), Strange et al. (2009), and Zheng, Yan, and Ren (2016). This section is based on Dahl and Sorenson (2012) and Parwada (2008). 23 For this literature see Bar Niv and Feldman (2004), Bhattacharya, Gaplin, and Haslem (2007), Clermont and Eisenberg (1996), Karpoff and Lott (1999), and Moore (2003). This section is based on Bar Niv and Feldman (2004) and Bhattacharya et al. (2007). 24 See, for example, Ahearne et al. (2004), Coeurdacier and Rey (2013), Coval and Moskowitz (1999), French and Poterba (1991), Huberman (2001), Tesar and Werner (1995), and van Nieuwerburgh and Veldkamp (2009). 25 See, for example, Guiso et al. (2008). 26 See, for example, Uppal and Wang (2003). 27 See, for example, Cohen (2008). 28 In what follows, the domicile status of firms is used interchangeably with the term “nationality.” 29 For this literature, see also Dawson and Dobson (2010), Neave and Wolfson (2003), Pettersson-Lidbom and Priks (2010), Ridder, Cramer, and Hopstaken (1994), Rocha et al. (2013), Watson (2013). This section is based on Areni (2014) and Watson (2013).

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Trajtenberg, M., 1990, “A Penny for Your Quotes: Patent Citations and the Value of Innovations,” Rand Journal of Economics, 21:1, 172–187. Trionfetti, F., 1997, “Public Expenditure and Economic Geography,” Annales d’Economie et de Statistique, 47, 101–120. Trionfetti, F., 2000, “Discriminatory Public Procurement and International Trade,” World Economy, 23, 57–76. Trionfetti, F., 2001, “Public Procurement, Market Integration, and Income Inequalities,” Review of International Economics, 9, 29–41. Uppal, R. and Wang, T., 2003, “Model Misspecification and Underdiversification,” Journal of Finance, 58:6, 2465–2486. Uysal, Vahap B., Kedia, Simi, and Panchapagesan, Venkatesh, 2008, “Geography and Acquirer Returns,” Journal of Financial Intermediation, 17, 256–275. Vagstad, S., 1995, “Promoting Fair Competition in Public Procurement,” Journal of Public Economics, 58, 283–307. Vairo, G.M., 1998, “Forum Selection: Case Removal,” National Law Journal, 21, B14. Verlegh, Peeter W.J., 2007, “Home Country Bias in Product Evaluation: The Complementary Roles of Economic and Socio-Psychological Motives,” Journal of International Business Studies, 38:3, 361–373. Verspagen, B., 1997, “Estimating International Technology Spillovers Using Technology Flow Matrices,” Weltwirtschaftliches Archiv, 133, 226–224 Wall Street Journal, 1999, “The Outlook, U.S. Accounting Board Faults Global Rules,” Wall Street Journal, October 18. Wall Street Journal, 2002, “EU to Embrace Accounting Method Not Used in U.S.,” Wall Street Journal, June 6. Watson, John, 2013, “Australian Football League: ‘Home Advantage,’ ‘Umpire Bias’ or Both,” Sport, Business, and Management: An International Journal, 3:3, 176–188. Weber, Mary J., Lambert Jr., John Timothy, Conrad, Kelly A., Jennings, Sherry S., and Mastal Adams, Jennifer R., 2018, “Discovering a Cultural System Using Consumer Ethnocentrism Theory,” System Practice and Action Research, 31:6, 617–636. Weichenrieder, A., 2001, “Public Procurement in the Presence of Capital Taxation,” Regional Science and Urban Economics, 31, 339–353. White, H.D., Wellman, B., and Nazer, N., 2004, “Do Citations Reflect Social Structure?,” Journal of the American Society for Information Science and Technology, 55:2, 111–126. Wolf, Holger C., 2000, “Intra-National Home Bias in Trade,” Review of Economics and Statistics, 82:4, 555–563. Zeller, R.A. and Jurkovac, T.A., 1989, “A Dome Stadium: Does it Help the Home Team in the National Football League?,” Sport Place: An International Journal of Sports Geography, 3:3, 37–39. Zhao, H., Seibert, S.E., and Lumpkin, G.T., 2010, “The Relationship of Personality to Entrepreneurial Intentions and Performance: A Meta-Analytic Review,” Journal of Management, 36:2, 381–404. Zheng, Ying, Yan, Daying, and Ren, Bing, 2016, “Institutional Distance, Firm Heterogeneities, and FDI Location Choice of EMNEs,” Nankai Business Review International, 7:2, 192–215. Zhu, Ning, 2002, The Local Bias of Individual Investors, Working paper, Yale University. Zodrow, George R., 2010, “Capital Mobility and Capital Tax Competition,” National Tax Journal, 63:4 (Part 2), 865–902. Zomaya, A.Y. and Sakr, S., 2017, Handbook of Big Data Technologies, Berlin and Heidelberg: Springer.

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The purpose of this chapter is to discuss “us and them” – a distinction that accompanies place attachment. This chapter argues that monoculturalism creates tension as it converts “us and them” to “us vs. them;” however, multiculturalism mitigates the tension as it converts “us and them” to “us with them.” To elaborate, the chapter starts, in Section 4.1, with a discussion of the dual-process social psychology, which considers a spectrum with two extreme processes of effortless heuristic and effortful systematic. Whereas the former, heuristic process is more prone to bias, the latter, systematic process tends to reduce the bias. In Section 4.2, the chapter discusses place attachment as a cultural group’s definition of and relationship with place. In Section 4.3, the chapter discusses the monoculture–multiculture spectrum, which contains the following stages: (1) monoculturalism, (2) cross-cultural contact, (3) cultural conflict, (4) educational interventions, (5) disequilibrium, (6) awareness, and (7) multiculturalism. The monoculture–multiculture spectrum operates in a parallel fashion with the heuristic–systematic spectrum. A typical resident who is socialized into the culture of the place takes such culture for granted and acts on it as his/her heuristic. However, if the typical resident of the place learns about multiculturalism, then he/she modifies the taken-for-granted culture and acts on it as his/her systematic. In Section 4.4, the chapter argues that whereas the monoculture–heuristic pair is biased, creates tension, and converts “us and them” to “us vs. them,” the multiculture–systematic pair is unbiased, avoids tension, and converts “us and them” to “us with them.” The chapter concludes by stating that multiculturalism mitigates home bias.

4.1 Dual-process social psychology This section provides an overview of the heuristic–systematic model, which is a typical dual-process social psychological model that considers heuristic and systematic modes of information processing, along with the social-cognitive principles thought to govern the activation and use of stored knowledge. This typical model involves a continuum that has two extremes of effortless, heuristic process and effortful, systematic process. Whereas the former, heuristic process is more prone to bias, the latter, systematic process tends to reduce the bias.1

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Within any specific judgmental context, the heuristic–systematic model delineates two basic modes through which perceivers may determine their attitudes and other social judgments. Systematic processing involves a relatively analytic and comprehensive treatment of judgment-relevant information. Judgments formed on the basis of systematic processing are, accordingly, responsive to the actual content of such information. By its very nature, systematic processing requires both cognitive ability and capacity. For instance, in a specific judgmental domain, systematic forms of processing are less likely to be seen among perceivers who possess little knowledge in the domain, or among individuals who are processing with time constraints. The other basic mode, heuristic processing, involves the activation and application of judgmental rules or heuristics (e.g., “Experts’ statements can be trusted,” “Length implies strength,” “Consensus opinions are correct”). Such rules or heuristics, like other knowledge structures, are presumed to have been learned and stored in memory. Judgments formed based on heuristic processing reflect easily processed judgment-relevant cues (e.g., message length), rather than individualistic or particularistic judgment-relevant information. Relative to systematic processing, heuristic processing makes minimal cognitive demands on the part of the perceiver. The heuristic mode is constrained by social-cognitive principles of knowledge activation and use – namely, availability, accessibility, and applicability. More specifically, judgment-relevant heuristics must be stored in memory (i.e., available); must be retrieved from memory and used (i.e., accessible); and must be applicable – that is, relevant to the judgmental task at hand. Reflecting the widespread notion of perceivers as limited in cognitive resources, and thus as “economyminded” information processors, the heuristic– systematic model assumes that perceivers are guided partly by the principle of least effort. That is, in the interest of economy, the heuristic processing often predominates over the relatively more effortful systematic processing. Beyond economy, however, information processing is often guided by motivational concerns. Recognizing this, the heuristic–systematic model incorporates the principle of least effort into its sufficiency principle, which maintains that perceivers attempt to strike a balance between minimizing cognitive effort, on the one hand, and satisfying their current motivational concerns, on the other. That is, perceivers who are motivated to generate accurate judgments will exert as much cognitive effort as is necessary (and possible) to reach a sufficient degree of confidence with respect to their judgment-accuracy goals. For any specific judgment, the sufficiency principle proposes a judgment-confidence continuum, along which two critical points lie: one designating perceivers’ level of actual confidence; the other designating their level of desired confidence, or sufficiency threshold. Perceivers will exert cognitive effort until their level of actual confidence reaches (if it can) their sufficiency threshold, thereby closing the gap between actual and desired levels of confidence. When low-effort heuristic processing fails to provide sufficient judgmental confidence (or cannot occur due to, for example, the lack of any judgmentrelevant heuristic-cue information),

200 A look into the future perceivers are likely to engage in systematic processing in an attempt to close the confidence gap. Although systematic processing is generally more effective than heuristic processing in decreasing the gap between actual and desired confidence, engaging in systematic processing does not guarantee that the gap will be closed. Predicting which processing mode will be undertaken follows directly from the sufficiency principle. Systematic processing is more likely to emerge when the gap between the actual and the desired judgmental confidence is widened as a result of either an increase in one’s sufficiency threshold (e.g., when the importance of the judgment task is enhanced), or a decrease in one’s level of actual confidence (e.g., when judgment-relevant information contradicts the judgmental implications of previously encountered heuristic-cue information). This prediction assumes that perceivers generally believe that more processing will provide them with more confident judgments. When this self-efficacy expectation is not held, increasing the gap between actual and desired confidence will not necessarily instigate systematic processing. It is important to note that the sufficiency principle is based on a judgmental continuum, which implies that varying degrees of heuristic and systematic processing may occur, corresponding to variations in the extent of the confidence gap. And of course, as discussed above, heuristic and systematic processing depend not only on one’s motivational concerns, but also on the availability, accessibility, and applicability of judgment-relevant heuristics, as well as the availability of adequate cognitive resources. Although either processing mode may occur alone, the heuristic–systematic model delineates specific and predictable ways in which heuristic and systematic processing may occur at the same time. Below, several patterns of such occurrence are described, in which situational, cognitive, and motivational factors that render one pattern more or less likely than another are pointed out. The heuristic–systematic model’s additivity hypothesis refers to situations where heuristic and systematic processing may exert independent and judgmentally consistent effects. For instance, in a situation where participants were asked to make evaluations of a consumer product, when the judgmental implication of a brand-name heuristic was congruent with the judgmental implication of attribute information about the product, participants who were led to believe that their product evaluations would be highly consequential based these evaluations on both their heuristic and systematic processing of the product information. The model’s bias hypothesis refers to the notion that the judgmental implications of heuristic-cue information may establish expectancies about subsequently encountered judgment-relevant information, which in turn may bias the nature of more effortful systematic processing of the judgment-relevant information. Such bias is most likely to occur in judgmental settings where individuating judgment-relevant information is ambiguous and hence amenable to differential interpretation, or when no such information is provided but perceivers generate judgment-relevant cognitions of their own. For instance, in a situation where exposure to heuristic-cue information (i.e., source credibility) led participants,

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who were told that their judgments would be highly consequential, to systematically process ambiguous individuating information about the object of judgment in ways congruent with the judgmental implications of the source credibility information. More specifically, participants exposed to the high-credibility heuristic cue elaborated upon the ambiguous information in more favorable ways than did those exposed to the low-credibility cue, presumably because high source credibility engendered favorable expectancies about the ambiguous individuating information. In turn, participants’ biased systematic processing of this ambiguous information predicted their judgments about the object. Heuristic and systematic processing may also work in opposition – which represents the model’s attenuation hypothesis. For example, the judgmental implications derived from systematic processing may contradict, and thus attenuate, the judgmental impact of heuristic processing. For instance, highmotivation participants in a situation were presented with consensuscue information that was either congruent or incongruent with the valence of individuating information about the object of judgment. When the judgmental implication derived from their heuristic processing of consensuscue information was incongruent with that of their systematic processing of the individuating information, these highly motivated participants relied solely on their more effortful cognitions to determine their judgments. The above examples illustrate the predictability of the co-occurrence of heuristic and systematic processing. In the same way that the knowledge of the characteristics of the perceiver and of the current judgmental setting permits predictions of when each processing mode is likely to occur alone, knowledge of these same parameters enables predictions regarding the cooccurrence of heuristic and systematic processing and its particular form. For instance, situational factors such as the presence of heuristic-cue information – as well as its congruence with other available, judgment-relevant information – may largely determine the nature of perceivers’ heuristic and systematic processing. More specifically, assuming adequate cognitive resources and relatively high levels of motivation, if the judgmental implication of heuristic-cue information is congruent with that of other available judgment-relevant information, perceivers may well engage in heuristic and systematic processing in additive ways. However, if the judgmental implication of the heuristic-cue information is incongruent with other available judgment-relevant information, perceivers’ systematic processing is likely to attenuate the judgmental impact of the heuristic cue. In contrast, if perceivers have neither the cognitive resources nor the motivation to process systematically, whether heuristic-cue information is congruent or incongruent with other available judgment-relevant information, it will exert little, if any, impact on the nature of information processing. In both cases, perceivers are likely to engage in heuristic processing, resulting in judgments that directly reflect the judgmental implications of the heuristic-cue information.

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4.2 Place attachment A theoretical framework is provided here to understand a cultural group’s definition of and relationship with place in general, and nature and the environment in particular. The framework defines landscape as the symbolic environment created by a human act of conferring meaning on nature and the environment. This landscape reflects the self-definitions of people within a particular cultural context. The transformation of the physical environment into landscape reflects people’s definitions of themselves and how these landscapes are reconstructed in response to people’s changing definitions of themselves.2 Every river is more than just one river. Every rock is more than just one rock. Why does a real-estate developer look across an open field and see comfortable suburban ranch homes nestled in quiet cul-desacs, while a farmer envisions endless rows of waving wheat, and a hunter sees a five-point buck cautiously grazing in preparation for the coming winter? The open field is the same physical thing, but it carries multiple symbolic meanings that emanate from the values by which people define themselves. The real-estate developer, the farmer, the hunter are definitions of who people are, and the natural environment – the physical entity of the open field – is transformed symbolically to reflect these self-definitions. These symbolic meanings and definitions are sociocultural phenomena, not physical phenomena, and they transform the open field into a symbolic landscape. Landscapes are the symbolic environments created by human acts of conferring meaning to the nature and the environment, of giving the environment definition and form from a particular angle of vision and through a special filter of values and beliefs. Every landscape is a symbolic environment. These landscapes reflect our self-definitions that are grounded in culture. Our understanding of nature and of human relationships with the environment are really cultural expressions used to define who we were, who we are, and who we hope to be at this place and in this space. Landscapes are the reflection of these cultural identities, which are about us, rather than the natural environment. When attempting to identify and understand the potential human consequences of changes in the natural environment, it is imperative that these consequences are understood in relation to the many cultural definitions that create landscapes. Is the landscape created by the real-estate developer, the farmer, or the hunter? Actually, any physical place has the potential to embody multiple landscapes, each of which is grounded in the cultural definitions of those who encounter that place. Every river is more than just one river. Every rock is more than just one rock. Cultural groups transform the natural environment into landscapes through the use of different symbols that bestow different meanings on the same physical object or condition. These symbols and meanings are sociocultural phenomena; they are social constructions, and they result from ongoing negotiations in a cultural context. Of course, humans reside in a natural world that is “there,” but this world is meaningless. Meanings are not inherent in the nature of things.

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Instead, the symbols and meanings that comprise landscapes reflect what people in cultural groups define to be proper and improper relationships among themselves, and between themselves and the physical environment. An example may help illustrate how landscapes are the reflection of sociocultural symbols and meanings that define what it means to be a human being in a particular culture. In Lexington, Kentucky, U.S.A., the great thoroughbred estate of Calumet Farm had fallen on hard times. The estate had been the home of many world champions and had come to symbolize the place of Lexington in the international world of the sport of kings. Local people expressed great concern that the estate would be subdivided and developed as a residential housing or a shopping mall. The local government began to consider expensive schemes to save this locally important site. Every major metropolitan newspaper in the country reported that Calumet Farm – the home of internationally famous thoroughbreds and the heart of the Bluegrass horse country – would be put on the auction block. A collective sigh of relief and a standing ovation greeted the new owner of Calumet when he proclaimed that he intended to change not a single blade of grass. For many people of the Bluegrass country and thoroughbred breeders, something much more, something qualitatively different from just a farm, was saved that day. The symbolic representation of a collective local history – the essence of a collective self-definition that has dominated the region for generations and was embodied in the landscape of Calumet Farm – had been saved. What this and other landscape examples suggest is that definitions of nature and the environment are grounded in various symbols through which cultural groups transform the nature and the world that is “there” into meaningful subjective phenomena. To understand human relationships with the natural environment, the subjective symbols and meanings through which a group of people socially constructs the landscape must be described. Natural phenomena are sociocultural phenomena in the sense that they are constructed through social interactions among members of a culture as they negotiate the meanings of nature and the environment. Various conceptions of nature are created from different social and cultural contexts, and nature then becomes indistinguishable from that context. Each culture constructs its own world out of the infinite variety of nature. Nature is socialized, reorganized, and made into a material manifestation of social structure. The natural environment is transformed into culturally meaningful phenomena and then is viewed from the perspective of these cultural definitions. A sociocultural group constructs a landscape from nature and the environment through culturally meaningful symbols, and then reifies it. Shared, takenfor-granted, and reified symbols and meanings that emerge through processes of negotiation thus define social and natural phenomena and the situations in which they are located. These intersubjectivc definitions of the situation, rather than the situations per se, constitute reality for that group of people. Cultural groups continue to reconstruct and redefine their realities – past, present, and future – through ongoing social interactions, which may be thought of as negotiations over meaning, that reinforce and change the symbols, meanings, and definitions of the situation.

204 A look into the future Symbols and their meanings change over time, but they have a persistence that gives them long-term continuity. Human societies have experienced natural and social calamities – earthquakes, volcanic eruptions, hurricanes, wars, riots – since the beginning of time, but with a core of continuity, survival, and reconstruction evident. It is the use of systems of symbols that makes this core possible. Thus, understanding symbol systems is essential to understanding relationships between human societies, nature, and the environment. How can a landscape persist and sustain a core understanding of human–natural environment relations among a group of people in the face of technological, economic, and other changes? Lying beneath what is the relatively observable worldview of a culture is a structure of beliefs that is shared in a community. These are shared convictions of what is the proper form of a system of values. This structure of beliefs is comprehensive and is so taken for granted, so implicitly obvious to the individual, that it is indistinguishable from the person’s self-definition. It is here, then, in the structure of beliefs that the most tenacious, most significant symbols are embedded and maintained. Overlaying this structure are superficial manifestations of the structure of beliefs, and these manifestations are quite changeable. New technologies or other externally introduced changes may represent such superficial manifestations, and may be voluntarily incorporated into the lives of people in ways that enhance or, at a minimum, do not contradict their self-definitions and taken-for-granted relationships to each other and to their landscapes. The belief structure is something that people bring to a new situation that needs definition and provides a context within which negotiations over the meaning of the situation occur. Thus, the more durable traditional symbols and beliefs provide people with an interpretive framework – a familiar context – within which they can construct the meanings of new technologies and other changes. Cultural groups use symbols to define the natural environment and fit it into their ongoing, everyday, taken-for-granted worlds within which they organize both their relationships to each other and their relationships with the environment. The natural environment is transformed through symbols and concepts that organize people’s relationships in the social world. The natural environment as a symbolic social construction is reified by the sociocultural group. Reification implies that humans are capable of forgetting their own authorship of the human world. Human meanings are no longer understood as world-producing, but as being, in their turn, products of the “nature of things.” As such, the symbolic social constructions – and here the landscape is included – become part of the world taken for granted. Members of the group act with the intuitive knowledge that their relationships to the natural environment could be no other way. Ideas and the realities they inform are naturally and indissolubly bound up together. Cultural groups socially construct landscapes as reflections of themselves. In the process, the social, cultural, and natural environments are meshed and become part of the shared symbols and beliefs of the groups.

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Taken together, these perspectives suggest that individuals perceive and categorize that which is given – the social and natural environment – in terms of intersubjective, taken-for-granted symbols and meanings, and thereby define the situations in which they are located. These definitions of the situations constitute reality for those who share these meanings. As the context changes – as environmental change occurs, for example – there is no inherent meaning to the change. Instead, people negotiate the meaning of the contextual or environmental change as a reflection of their changing definitions of themselves. In this sense, then, nature and the environment are socially and culturally constructed through these social processes and become landscapes through social interaction and negotiation.

4.3 Multiculturalism Multiculturalism means having a broad multicultural perspective.3 It reflects the fact that human existence is inherently and universally multicultural, although until recently humankind has overlooked it throughout history. This neglect is probably the result of the survival imperative of the ethnocentric impulse, which sees submerging oneself in similarities as a safer path to survival than trying to deal with differences. Multiculturalism implies a set of principles, a multicultural perspective, based on which people act in a multicultural society. The first step toward multiculturalism is awareness of the ethnocentric impulse. This is buried deeply in the unconscious and culturally-determined patterns of thinking and behavior. These act as powerful, built-in barriers to accepting that society is multicultural. Thus, the first steps toward multicultural living consist of: (1) becoming aware of one’s own ethnocentric conditioning; and (2) accepting the fact that society is multicultural. Multicultural education uses the framework of formal education to develop in teachers and students both multicultural awareness and the fundamental skills needed for living in a multicultural world. Culture can be regarded as knowledge, as shared patterns of information that a group uses in order to generate and convey meaning among its members. Every group creates a system of shared knowledge that is necessary for its functioning and survival; and the group uses it to facilitate communication among its members. These shared patterns of information can be explicit or implicit. They are the outcomes of ecological, historical, and contemporary adaptive needs. They are comprised of subjective components (beliefs, attitudes, values); interactive components (verbal and nonverbal language); and material components (artifacts). These systems of knowledge, or cultural realities, arise from both macrocultural dimensions (such as ethnicity and nationality) and micro-cultural aspects of human existence (family, religion, occupation, age, sex, vocational interests, etc.). When these micro-cultures (identity groups) are combined with macro-cultures (the vast array of national, ethnic, and racial groups), it becomes clear that multiculturalism pervades human society – that is, human beings live in a multicultural world.

206 A look into the future Individuals within a micro- or macro-culture share their respective culture’s specific patterns of information to a significant degree. Their macro- and micro-cultural experiences shape their worldview and reality, and influence their interactions with others. When their cultural patterns of information are not shared by others, differing realities clash, cultural conflicts arise, and communication breaks down, resulting in internal (personal) and interactional (social) tensions, and reinforcing cultural isolation, prejudice, and mistrust. In the multicultural world, human beings continuously encounter different cultural realities, from which cultural conflicts inevitably arise. Multicultural education recognizes that these conflicts are inevitable; attempts to ameliorate them; and notes that in this process positive learning takes place. Cross-cultural conflicts can help different aspects of cultural learning, including the development of cultural self-understanding and awareness, the enhancement of knowledge about other cultural realities, and the improvement of cross-cultural communication skills. Denying or disregarding the existence of cultural conflicts perpetuates them. In contrast, acknowledging the existence of cultural conflicts, and incorporating them into the multicultural education process, potentially lead to their reduction. Multicultural education may be defined as involving: (1) recognition of the universality of multiculturalism; (2) development of cultural self-awareness; (3) willingness to learn about one’s own and others’ cultural realities; (4) acceptance of the existence of cultural conflicts; and (5) improvement of communication with people from other cultures. Culture subtly, purposefully, and without individuals’ conscious awareness, imbues them with notions of reality that act as a shared meaning in their interactions with others. For a group of individuals, it supplies, maintains, and perpetuates the familiar, which allows them to understand their world. Culture, with its powerful spell, does not let individuals easily accept the existence and validity of other cultural perspectives. The strong spell of culture leads individuals to hold to their own culture as long as they can, because they are led to believe that there is a painful loss in admitting the relativity of their cultural reality and the validity of others’. When individuals break the spell of culture, they become richer because they know more about themselves and have an expanded cultural vision. From the clashing of cultural realities, individuals learn about their own cultural conceptions as well as others’. They discover a new way of seeing themselves and a new way of seeing others. They understand and expand their cultural and conceptual preconditioning. They feel free to accept other cultural conceptions and to examine their own culture with constructive and critical eyes. One of the by-products of this process is an understanding of the feeble nature of knowledge. If reality is culturally-conceived, then the notion that knowledge is absolute is challenged. Multiculturalism is the opposite of dogmatism, as it points to the inevitable contradictions embedded in everything humans learn. Thus, a multicultural perspective encourages people towards learning about themselves as well as comprehending the realities of others. Through this process, people also learn to tolerate the uncertainty of knowledge.

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The progressive movement towards multiculturalism can be thought of as consisting of the following seven stages: monoculturalism; cross-cultural contact; cultural conflict; educational interventions; disequilibrium; awareness; and multiculturalism. 4.3.1 Monoculturalism At this initial stage, individuals regard their interpretation of the world as best and universal. They perceive other ways of behaving and thinking as either strange or inferior. This is the stage of ethnocentrism, which is both inevitable and universal. It starts in childhood, when the child’s parents, environment, religion, and social traditions are all taken for granted, and help form the child’s identity and ensure the child’s psychological belonging, security, and stability. These familiar environmental factors provide the indispensable basis for existence, and as a result they are valued positively. When children grow up with certain style of cooking and customs, then as adults they come to like them. Consequently, anything that is not familiar may be looked down upon or perceived as a threat to the identity of the group. The strong defense of one’s values (the familiar) may lead to hatred and aggressive acts toward those with different values. The main characteristic of the monocultural stage is that people have not yet realized the inevitability and universality of ethnocentrism. People characterize their own cultural information as unique and superior. They may, consciously or unconsciously, tend to impose their cultural patterns on others and expect them to follow accordingly. 4.3.2 Cross-cultural contact The process toward multiculturalism begins by individuals’ direct or indirect contact with other cultural groups. Individuals compare and contrast different patterns of cultural information to their own, and begin the questioning process. However, at this stage individuals are not aware that there are diverse cultural patterns. 4.3.3 Cultural conflict Cultural conflict involves the clashing of different cultural patterns and the confrontation of two or more ethnocentric views. Cultural conflict occurs as a result of the collision between two or more groups, each of which sees its own folkways as unique. This confrontation intensifies ethnocentrism, and leads each antagonist to further differentiate itself from the other. They perceive the world as divided between “us” and “them.” The degree of intensity of the results of cultural conflict may range from miscommunication, reinforcement of false perceptions, and different forms of hostility, to individual and social feelings of depression, marginality, and alienation. Cultural conflict becomes very damaging when one group forces its cultural patterns on another.

208 A look into the future 4.3.4 Educational interventions Educational interventions can help in the amelioration of cultural conflict and the development of a multicultural perspective. Curricular programs can serve to narrow the communication gap in situations of micro- and macro-cultural conflict. These may include self-awareness; common human condition themes and cultural differences; cognitive imposition vs. cognitive choice according to cultural needs of students; personally-relevant knowledge; inquiry vs. dogmatism; and prevalence of micro-cultural realities. 4.3.5 Disequilibrium For cognitive development, disequilibrium of mental structures is necessary for the assimilation of new knowledge. More specifically, knowledge and intellectual development take place through the twin mental processes of assimilation and accommodation. While interaction with the environment occurs, the individual assimilates certain elements into their already existing mental structures. This upsets the equilibrium in mental organization because mental structures change to accommodate new data. In the context of the amelioration of cultural conflict, disequilibrium involves a balance between the need to protect sameness and continuity on the one hand, and the need to accommodate change on the other. In the process of multiculturalism, disequilibrium occurs when previously-held knowledge is challenged or invalidated by new cultural encounters. At this stage, individuals begin to doubt and question some of their attitudes and beliefs. They go through an emotional and intellectual struggle as they begin to internalize the concept of culture and its power and arbitrariness in influencing thought and behavior. 4.3.6 Awareness At this stage the individual has completely surpassed ethnocentrism and has begun to understand the concept of culture. The individual has re-established a new equilibrium and has started the process of accommodating the new knowledge. 4.3.7 Multiculturalism Individuals with multicultural perspective have achieved a new mental and emotional consciousness that enables them to negotiate new formations of reality more readily. At this stage, individuals have been able to internalize the historical and contemporary contradictions that are embedded in the human condition. The individuals hold a multicultural style of thinking and feeling, which is tolerant of cultural differences, the ambiguities of knowledge, and variations in human perspective. They reject simple answers and appreciate inquiry. They question the arbitrary nature of their own culture, and believe

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that people from other cultures can enrich their experience. They are aware and able to incorporate and synthesize different systems of cultural knowledge into their own. They can be recognized by the configuration of their outlooks and worldviews.

4.4 Us and them Commonly, place has been regarded (Relph, 1976; Tuan, 1974, 1977) as a bounded entity with unique identity and historical continuity, a cozy place of rest, and defense against the dangerous and alien “outside.” That is, “us and them” has been one of the dimensions of place, and therefore place attachment tends to embody the sense of “us vs. them” and creates the tension between “us” and “them.” This tension may be more imagined and socially constructed than real, and lead residents of the place to be more inward-looking and become more provincial. A typical resident of a place, who is socialized into the culture of the place, takes “us vs. them” for granted and joins the other residents of the place. “Us vs. them” acts as the heuristic that underlies the judgments, decisions, and actions of the typical member of the place. As long as this member acts on the “us vs. them” heuristic, he/she will live a biased life. However, the typical member of the place, through life experience or cultural change, may develop beyond the “us vs. them” heuristic (monoculture–heuristic) and make progress toward multiculture–systematic. Such a move takes place across a spectrum. Indeed, there are two parallel spectrums: one is the heuristic–systematic spectrum (discussed in Section 4.1); the other spectrum is the monoculture–multiculture spectrum (discussed in Section 4.3). How far the typical member of the place will move from the monoculture–heuristic end of the spectrum to the multiculture–systematic end of the spectrum depends on the degree of their progress in overcoming the taken-for-granted assumptions of the culture in which they were socialized. The further they move away from the monoculture–heuristic and the closer they get to the multiculture–systematic, the more unbiased a life they will live. Whereas the monoculture–heuristic is biased, embodies “us and them,” and creates tension, the multiculture–systematic is unbiased, denies “us and them,” and removes this tension. The above discussion has implications with respect to some aspects of the place attachment literature (as discussed in the review article by Lewicka 2011a), as follows. 4.4.1 Internalizing mobility The effect of the increase in mobility on place attachment depends on how mobility is internalized within the culture of the place, as place attachment is socially constructed. Similarly, the effect of the increase in globalization on place attachment depends on how globalization is internalized within the culture of the place, as place attachment is socially constructed.

210 A look into the future Lewicka (2011a), in her review of the literature, poses the question: How important are places for people nowadays? Lewicka (2011a) elaborates that the world has changed compared to the 1970s and early 1980s. Considering the increased mobility, globalization, growing homogeneity of places, and loss of their cultural specificity, is place still important for people? If place is defined, as it was in the classical works, through its historical continuity, unique character, boundedness, and opportunity for rest, then modernity, globalization, fast speed, and virtualization of everyday life should destroy places and undermine people’s meaningful relations with them (sense of place, place attachment). However, Lewicka (2011a) refers to the abundant research results indicating that attachment to numerous places continues to be strong. This concerns both attachment to the closest place scales, like home or neighborhood; to higher levels, such as cities or towns; and to non-residential places, like recreation areas. Place attachment has been found to be present despite increased mobility, commuting to other cities or countries for work, or having more than one place of residence. Lewicka (2011a) emphasizes that these findings do not contradict other findings, which demonstrate that strength and type of place attachment vary, and depend on additional factors associated with both places themselves (their scale, size, physical and social characteristics) and people (their social and economic status, residence length and mobility, age, sense of security, social relations in the place, value system, etc.). The above review of research from Lewicka (2011a) is consistent with the statement that the effect of increased mobility and globalization on place attachment depends on how mobility and globalization are internalized within the culture of the place, as place attachment is socially constructed. 4.4.2 Internalizing scale A move toward the multiculture–systematic end of the spectrum does not mean that an individual would lose their place attachment. Multiculturalism offers additional opportunities for place attachment scale. In terms of attachments to different place scales (home, neighborhood, city, state, nation, continent), the more the culture of the place internalizes the multiculture–systematic, the more it provides its residents additional opportunities on place attachment scales. Lewicka (2011a), in her review of the literature, notes that with increased mobility and improved facilities that help overcome large distances, people’s geographic horizons also expand. Whereas traditional societies were strongly localized, confined to their villages and parishes, processes of globalization and increased mobility stretch potential targets of identification to the level of continents and the whole world. Intensive changes in this respect have taken place within the past 40 years (rapid development of the internet, European integration, fall of the Iron Curtain, political and economic migrations, etc.). Lewicka (2011a) poses the following question: Does that mean that nowadays people feel more attached to higher-level places and demonstrate attitudes that are cosmopolitan rather than local? She refers to the work of Gustafson (2009),

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who compared three groups of Swedish citizens, differing in mobility (frequent travelers, occasional travelers, and non-travelers), with respect to different measures of attachment (sense of belonging, willingness to move, etc.), rated with respect to several place scales (local, regional, national, and European). Gustafson found that frequent travelers felt stronger emotional bonds with larger place scales, such as Europe, and were more willing to live abroad, but at the same time did not express less attachment to their city, region, or nation (Sweden) than non-travelers. Additionally, they showed stronger involvement in local actions and generally expressed stronger social capital than non-travelers. Similarly, Lewicka (2011b), in a representative Polish survey, found higher involvement in local actions and higher social capital were shown by those participants whose attachments combined local and European scales, compared with those who were only local. Lewicka’s (2011b) study also revealed a large group of Polish citizens whose identities included both local and global place scales, demonstrating that different place scales are not mutually exclusive. The above review of research from Lewicka (2011a) is consistent with the statement that multiculturalism offers additional opportunities for place attachment scale. That is, the more the culture of the place internalizes the multiculture– systematic, the more it provides its residents additional opportunities of place attachment scales (home, neighborhood, city, state, nation, continent, world). This also shows that multiculturalism should be considered as a factor contributing to the development of the type and extent of place attachment. 4.4.3 Internalising diversity The more the culture of a place internalizes the multiculture–systematic, the more that place becomes open to the diversity of the residents of the place, in the sense that there will be more interpersonal trust, more friendship, more collective work, more place attachment, more social capital, among diverse residents of the place. Lewicka (2011a), in her review of the literature, notes that research shows that socio-economic and racial diversity of neighborhoods contributed to a decline in place attachment (operationalized as house ownership and length of residence), and to a moderate extent undermined neighborhood attachment. Based on large survey data from representative country samples (U.S. and Canada), research has demonstrated a consistently negative relationship between the ethnic diversity of a neighborhood and interpersonal trust (both towards ethnically different and similar neighbors). Diversity also undermined other aspects of neighborhood life, such as collective actions undertaken, number of close friends, and general happiness. Research using Australian survey data found a negative relationship between neighborhood diversity and trust in neighbors, stronger for linguistic than ethnic diversity. If trust in neighbors and strength of neighborhood ties are considered important predictors of attachment, then these results indirectly suggest that ethnic diversity

212 A look into the future of neighborhoods undermines place attachment among community members. Oliver (2010) used American census data to demonstrate that racially diverse Americans tend to cluster into ethnically homogenous neighborhoods (predominantly White, Black, Asian, or Latino), the proportions of each deviating from the distribution representative for the whole country. A more important finding is that, although coexistence of Blacks, Asian, and Latinos in one neighborhood tended to increase mutual tolerance, it also decreased attachment to neighborhood. Lewicka (2011a) adds that people, however, seem to value diversity on levels higher than their own neighborhood (e.g., cities). Although exact empirical evidence showing that place attachment is positively related to city diversity is missing, there is some indirect evidence that the two may be related. For example, it is documented that multicultural cities attract tourists and representatives of the creative class. Although it may not appear so on first sight, the above review of research from Lewicka (2011a) is consistent with the view that the more the culture of a place internalizes the multiculture–systematic, the more that place becomes open to the diversity of the residents of the place, in the sense that there will be more interpersonal trust, more friendship, more collective work, more place attachment, more social capital, etc. among diverse residents of the place. The evidence presented by Lewicka (2011a) suggests that, overall, cultures are currently still monocultures and have not yet internalized multiculturalism. 4.4.4 “Us with them” Place attachment has an “us and them” dimension, which differentiates “us” from “them” and, historically, has created the tension represented by “us vs. them.” This tension is created because the division between “us” and “them” has been created within a monoculture, and cultures have been placed against each other. However, if the division between “us” and “them” is created within a multicultural view, then each culture is viewed as equal to the other and the tension is removed. That is, “us and them” is socially constructed such that in a monoculture the culture of the place imbues it as “us vs. them,” whereas in a multiculture the culture of the place imbues it as “us with them.” This mitigates the home bias.

4.5 Conclusion This chapter has brought to the fore the “us and them” dimension that is embodied in the definition of place attachment. This “us and them” dimension creates an unnecessary tension, which this chapter argues can be mitigated by multiculturalism. For this purpose, the chapter first discussed dual-process social psychology, place attachment, and multiculturalism; then argued that whereas the monoculture–heuristic is biased, embodies “us vs. them,” and creates tension; the multiculture–systematic is unbiased, denies “us vs. them,” converts “us vs. them” to “us with them,” and removes tension. This mitigates the home bias.

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Notes 1 For this literature, see Bargh (1984, 1989, 1994, 1997), Bargh and Chartrand (1999), Bargh et al. (1996), Bohner, Moskowitz, and Chaiken (1995), Bohner et al. (1998), Chaiken (1980, 1987), Chaiken, Giner-Sorolla, and Chen (1996), Chaiken, Liberman, and Eagly (1989), Chaiken and Maheswaran (1994), Chaiken and Trope (1999), Chaiken, Wood, and Eagly (1996), Chen and Chaiken (1999), Chen, Shechter, and Chaiken (1996), Cimpian and Steinberg (2014), Darke et al. (1998), Eagly and Chaiken (1993), Erb et al. (1998), Evans and Frankish (2009), Fiske and Taylor (1991), Forehand, Gastil, and Smith (2004), Gilovich and Griffin (2002), Gilovich, Griffin, and Kahneman (2008), Giner-Sorolla and Chaiken (1997), Higgins (1996), Kahneman (2011), Kahneman, Slovic, and Tversky (1982), Kossowska, Guinote, and Strojny (2016), Kuhnen (2010), Logan (1989), Maheswaran and Chaiken (1991), Maheswaran, Mackie, and Chaiken (1992), Martin and Hewstone (2003), Martin, Hewstone, and Martin (2007), Meleady and Crisp (2014), Meyers-Levy and Maheswaran (2004), Petty and Cacioppo (1986), Porcelli and Delgado (2009), Schneider and Shiffrin (1977), Shadlen and Shohamy (2016), Sherman, Gawronski, and Trope (2014), Shiffrin and Schneider (1977), Simon (1976), Tordesillas and Chaiken (1995), Whaley (2009), and Wood, Kallgren, and Preisler (1985). This section is based on Chen and Chaiken (1999). 2 For this literature, see Alexander (2002), Alkon and Traugot (2008), Brandenburg and Carroll (1995), Burley (2007), Buttimer (1980), Eisenhauer, Krannich, and Blahna (2000), Fishwick and Vining (1992), Franck (1987), Freudenburg, Frickel, and Gramling (1995), Greider and Garkovich (1994), Gustafson (2001), Kunstler (1993), Lewis (1979), Milligan (1998), Norberg-Schultz (1979), Peet (1999), Relph (1970, 1976, 1997), Sack (1980), Seamon (1980, 1982, 1987, 1993, 2000, 2002), Tuan (1974, 1975, 1977), Williams (2000). This section is based on Greider and Garkovich (1994). 3 For this literature, see Banks (2007), Banks and McGee (1989, 1995), Barber (1992), Baumann and Vertovec (2011), Chapman and Nikola (2010), DeMulder and Eby (1999), Gay (1995, 1997, 2002), George and Chattopadhyay (2008), Gollnick and Chinn (1986), Greene (1993), Guarasci and Conrnwell (1997), Gurin (1999), Hofstede (1980), Hannerz (1996), Hodgkinson and Starbuck (2008), Lynch (1989), Macedo (2000), Mann and Moser (1991), McDonough and Feinberg (2003), Nieto (1992, 1995), Parker (1996, 1997, 2002), Pratte (1979), Rodriguez (1983), Rojot (2008), Sigel and Hoskin (1991), Sims and de Martinez (1981), Sleeter (1991), Sleeter (1996), Stent, Hazard, and Rivlin (1973), Thompson and Tyagi (1993), and Zarate (2009). This section is based on Wurzel (2004).

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Index

academic institution 163 academic research citations 160–3 academic sociology 95 accounting: measurement process 157; normative theory of 157–8; standards 156–8; theory, primary goal of 157 acquirer return 149 acquisitions 40, 148–51; decisions 147; value creation in 149 actual portfolio holdings 39, 44 actual portfolio shares 25 Adler, Michael 6 Adorno, T.W. 146 ADRs see American depositary receipts (ADRs) agency costs 126, 133 agent proximity, importance of 135 aggregate economic growth 163 Aghion, Phillipe 133–4 Allen, T. 161 ambiguity 55, 208; aversion 61–2 American business school model 162 American depositary receipts (ADRs) 27, 31, 36, 44; programs 42 American Stock Exchange (AMEX) 24 AMEX see American Stock Exchange (AMEX) Anderson, C. W. 56 Areni, C. S. 173 Arespa, Marta 19 Aristotle 142 ASEAN see Association of Southeast Asian Nations (ASEAN) Asmussen, C.G. 140 aspect of reality 91 asset allocation 50; standard models of 53 asset markets 10, 18, 24 asset pricing theory 48

Association of Southeast Asian Nations (ASEAN) 141 asymmetric information 126, 130; assumption of 44 attenuation effect 150 attitude theory 95 Australian equities 3 authoritarian personality 146 Aviat, Antonin 124 awareness 208 Bacchiocchi, Emanuele 165 Backus, D. 6 Bacmann, Jean-Francois 126 Badarinza, Cristian 170–1 Bailey, W. 22 Baldwin, R. 160 banking: competition 132; industry 147; sector of Pakistan 132; supervision 133 bank lending 131, 147; price discrimination in 154 bank loans 124, 131; rates, geographic distance on 131 Baxter, Marianne 15, 18 Bayesian approach 34 Bayesian portfolio analysis 34 behavioral factors, home bias 46–7; ambiguity aversion 61–2; beliefs 60; competence 51–3; confidence 51; culture 54–9; familiarity 47–50; investor characteristics 59; loss aversion 60; narrow framing 60–1; optimism 53–4; peer comparisons and habit persistence 59; regret 50–1 behavioral finance 55 Bekaert, Geert 23 Beleska-Spasova, E. 140 Belgium 131–2

Index 221 beliefs 60, 141–2; differences in 60; structure of 203 Benos, E. 59 Berriel, Tiago C. 12, 19, 124 Bhattacharya, Uptal 169 Bhattarai, Saroj 12, 19, 124 bibliometrics 161 Big Five personality traits 166 bilateral goods trade 124 bilateral sectoral trade data 9 bilateral trade 143 bilateral trust 127–8 Black, Fischer 21 blind scholars 91 block acquirers 155 Bolliger, Guido 126 bond investment 40, 123–5 Bornhorst, Fabian 142 borrower 130–1; heterogeneity 132 Bottazzi, Laura 15, 127–8 Bradshaw, Mark T. 158 Branco, F. 159 Bretton Woods system 20 broader social system of mass society 89 Burger, John D. 3, 123 Burrell, Gibson 92 business education 162 Cai, Ye 150 Campbell, Donald T. 146 Canadian inter-provincial trade 144 capital account: liberalization of 122; liberalizations 1; movements 31 capital asset pricing model (CAPM) 3–4, 14, 48, 60; international 25, 46–7; tests 29 capital controls 20–3, 135 capital gains, traditional cost of 135–6 capital goods, bias on 19 capitalism 110, 112–13 capitalist production 112 capital markets 128; analysts on 128; segmented 134 capital mobility 134; international 135 capital stock 8 CAPM see capital asset pricing model (CAPM) Carey, Mark 130–1 Center for Research in Security Prices (CRSP)-size portfolios 28 Chinese firms 128 Chue, Timothy K. 6–7 circulation 111–12 citations 164; patterns 162 civic culture 108

civic place attachment 89 Clements, K.W. 161 clustering 137 Coase, Ronald H. 133 Cobb–Douglas production function 15 code-law accounting 157 code-law systems 156 coefficient of relative risk aversion (CRRA) 9 Coeurdacier, Nicolas 3, 9, 17, 124 Cohen, Laurent 142–3 Cole, Harold L. 19 collaboration effectiveness 161 collective local history 202 common-law countries 157 common-law legal system 156 communal peace, maintenance of 91 communication 110; means of 111 community: affiliation 108; attachment researchers 89; of interest 89; notion of 162; of place 89; sense of 88; types of 89 competence 51–3; hypothesis 52 confidence 51 conflicts of interest 128 consumer behavior 145 consumer ethnocentrism 59, 145; concept of 146; defined 146–7 Consumer Price Index (CPI) 25 consumers, ethnocentric 146 consumption-based approach 28 consumption-based model 28 consumption habit 59 contradiction 104 contribution pension money 48 Cooper, Ian 2, 6 Coordinated Portfolio Investment Survey 3 corporate borrowers 130 corporate debt decisions 130 corporate governance 153–6; differences in 45; and transparency 45–6 corporate-insider discretion 46 corporate loans 130 corporate mergers 151 corporate profits 14 corporate transparency 45 Correa, Marc 163 Cost Accounting Standards Boards 157 country-level patriotism 153 Coval, Joshua D. 123, 125–6, 136 CPI see Consumer Price Index (CPI) Craft, Timothy M. 19 credit risk 130 cross-border asset trade 1

222 Index cross-border equity 29, 40; diversification 4; flows 126; holdings 41, 124 cross-border investment 136–7, 170 cross-border mergers 153 cross-border trades 143 crosscountry nominal bonds 18 cross-cultural conflicts 206 cross-cultural contact 207 cross-industry transactions 147 cross-listing activity clusters 136 CRRA see coefficient of relative risk aversion (CRRA) crucial assumption 160 “cultural affinity” theory 31 cultural background, effect of 128 cultural bias 127, 129; definition of 143 cultural conflict 207 cultural differences 42, 55 cultural dimensions 55 cultural distance 124–5, 134 cultural groups 202 cultural homogeneity 137 cultural phenomena 99 cultural place meanings 85 cultural proximity 128, 135, 137, 143 cultural stereotypes 142 cultural values 55 culture 54–9; defined 141; documented importance of 57, 124; effect of 144; importance of 134; literature on 134; measure of similarity in 142; substantial impact of 55 Cummings, J.N. 161 Curran, Louise 139 currency 137–9; bond market 13; risk 47 curricular programs 208 customary beliefs 141–2 cynicism 107 Dahl, Michael S. 167 debt securities 16 Degryse, Hans 131–2 deliberative democracy, models of 106–7 Dellas, Harris 9 democracy, discursive models of 107 Demski, Joel S. 157 deprivation 103 Devereux, Michael B. 18 diaspora networks 31 differentiation in place identity 86 Dimmock, Stephen G. 61 Dinc, I. Serdar 151–3 “direct effect” of governance 46

discourses 107; of leisure 107; of retrospection and memory 108 discriminatory procurement 160 disequilibrium 208 distortionary taxation 159 diversification: benefits of 15; degree of 29; foreign 34; improvement in 34; potential benefits of 30 diversification costs 24–7; estimation based on consumption approach 27–9; estimation based on individual portfolio holdings 29–35 diversity, internalising 211–12 Dohmen, T.J. 172 dollar-denominated securities 138 domestic agents 9 domestic assets 50; information advantage on 39; payoff on 12 domestic banks 132–3 domestic bias 125; individualism on 56; in international bond portfolios 3 domestic capital formation 135 domestic capital stock 8 domestic debt securities 125 domestic equity 1, 3, 8, 32, 39, 56; actual holdings of 3; bias 8; equity investment in 2; foreign equity with 32–3; relative returns for 53; returns 44; shares 13; shares of 3 domestic firms 138; contracts to 159; profit of 18 domestic goods 145; systematic preference for 146 domestic inflation 6; risk 25–6 domestic investment opportunities 123, 134 domestic investors 36, 39, 44, 47, 51; superior performance by 43 domestic labor returns 15 domestic market 32; capitalization 2 domestic monetary 134 domestic nontradable firms 9 domestic portfolios 48, 138 domestic savings 135 domestic securities, from foreign investors 22 domestic shareholders 45 domestic stocks 6, 14, 35–6, 41–2, 51–2, 122; market index 32; preference for 153; total equity portfolio in 3 domestic suppliers 159 domination 103 DSGE models see dynamic stochastic general equilibrium (DSGE) models dual-process social psychology 198–201

Index 223 Duesenberry, J. 7 Dumas, Bernard 6 Dunning, J. 139–40 dynamics of accumulation 112 dynamic stochastic general equilibrium (DSGE) models 2, 4, 11 earnings per share (EPS) 129 economic behavior, theories of 125–6 economic contexts, variety of 170 economic integration 152 economic nationalis 152 economic nationalism 145, 151–3; importance of 152 economic policy, efficiency of 135 economic proximity 137 economic transactions, precondition for 170 educational interventions 208 elasticity of substitution 8 electronic trading 1, 122 emancipation 103 emerging markets 20 Engel, Charles 17–18 entrepreneurial fund managers 167–8 entrepreneur location choice 166–8 entrepreneurship 165–6; research 166; spatial variations in 166 environmental psychologists 85 environmental psychology: literature 96–7; theory 96 EPS see earnings per share (EPS) equities 19; analysis, context of 126; domestic bias in 8; holdings of 29; home bias in 8; local 1; portfolio of 1 equity: investment 122–3; markets, overseas listings in 136; portfolios 6, 12, 60; research, culture on 128; transactions 29–30 equity analysts 125–9; advantage of focusing on 125–6; forecasts and recommendations 126 equity-based approach 28 equity home bias 3, 10, 12, 15–16, 62, 124; academic research citations 160–3; accounting standards 156–8; bond investment 123–5; corporate governance 153–6; currency 137–9; description of 123; economic nationalism 151–3; entrepreneur location choice 166–8; entrepreneurship 165–6; equity analysts 125–9; equity investment 122–3; forum selection in law 168–9; government procurement 158–60; international business 139–43; international marketing

145–7; international trade 143–5; literature on 1, 125; loan market 130–4; mergers and acquisitions 147–51; patent citations 163–5; puzzling phenomenon 1; real estate 170–1; saving-investment 134–7; sport competition 171–3 Erel, Isil 151–3 Errunza, V. 21 ethnocentric consumers 146 ethnocentrism: Adorno view of 146; consumer 145–6 EU see European Union (EU) Euler equation 6–7 Eun, C.S. 21 European markets, corporate loans 130 European Union (EU) 141 Evans, T.S. 161–2 exchange rate volatility 123–4 familiarity 47–50, 55; attributes 50; preferences for 170 familiar markets 136 FDI see foreign direct investment (FDI) Feldstein, Martin 123, 134 Fidora, Michael 6, 123–4 finance literature 37 Financial Accounting Standards 157 financial assets 16 financial community 126 financial development, literature on 133 financial globalization 44, 122; process of 1 financial integration 1, 44 financial liberalization, importance for 135 financial macroeconomics approach 37 financial markets 21 Financial Times Stock Exchange (FTSE) 3 Finnish firms 126; stocks of 128 Finnish investors 40 Fishman, M.J. 148 floating exchange rates 134 foreign assets 2, 11, 37 foreign banks 132–3, 142; enforcement problems for 133; reluctance of 133 foreign bias 56; individualism on 56 foreign bonds: bias 125; perceived riskiness of 124 foreign capital investment 37 foreign currency 20, 138 foreign direct investment (FDI) 30–1 foreign diversification 34 foreign equities 4; diversification opportunities 1; with domestic equity 32–3; holdings 16, 30; investor into 34;

224 Index markets 30; returns 15; share of 4; U.S. holdings of 42 foreign institutional investors 43 foreign investments 20–1, 62; alternative cost of 30; attractiveness of 124; capital controls 20–3; costs, estimates of 26; deadweight costs of 25–6; implicit costs of 26; shadow costs of 25; transaction costs 23–35 foreign investors 29–30, 35–6, 43–6, 136–7; domestic securities from 22; portfolio bias of 136; in Thailand 22 foreign journals 163 foreign market 34, 136; proximity of 39–40; returns 36 foreign nationality 128 foreignness concept, liability of 139 foreign portfolios 138 foreign shares 30 foreign stocks 3, 21, 54; holdings 36 Fortunato, S. 162 forum non-convenience litigation 169 forum selection clauses 169 forum selection in law 168–9 Francois, J. 160 French, Kenneth R. 2, 25, 122–3, 167 Friedkin, N. 161 FTSE see Financial Times Stock Exchange (FTSE) Fuller, K. 149 functionalist paradigm 91–2, 94–9; with respect to place 95–9 fundamental returns 12 fund managers 167 Gaplin, Neal 169 GARCH model see generalized autoregressive conditional heteroskedasticity (GARCH) model general equilibrium macro models 2 general equilibrium model 10 generalized autoregressive conditional heteroskedasticity (GARCH) model 22 genetic distance 142 geographic cultural patterns 166 geographic dissemination 163 geographic distance 161 geographic frictions 145 geographic proximity 125, 135, 137, 143, 147–9, 156, 161; home research communities 162; importance of 153; information advantages 147–8; literature on 154; primary measures of 155; role in citation behavior 161; soft

information 149; synergies from 147; use of 150 German stock exchange 137 Germany 157 Giannetti, M. 124 Gifford, Robert 83 Glaister, K. 140 global allocation of capital 30 global commercial property transactions 170 global commercial real estate deals 171 global equilibrium asset pricing model 51 global funds, elastic supply of 134 global investment 30–1; positions 137 global investors 158 globalization/regionalization 141 global portfolios 138 global pricing 22–3 global willingness 138 GLOBE study 55 Golay, Frank 152 Gourinchas, Pierre-Olivier 17 governance activities 155 governmental capital controls 20 government procurement 158–60 government spending shocks 19 gravity models 141 group affiliation 173 group-framed place attachment 83 groups’ inferiority 146 Guiso, Luigi 141–3 Habermas, J. 106–7; theory of communicative action 106–7 habit persistence 59 Harvey, Campbell R. 23 Harvey, D. 109 Haslem, Bruce 169 Hau, Harold 4 Heathcote, Jonathan 8, 15, 19 heterogeneity 5; borrower 132 heuristic processing 199–200; judgmental impact of 201 heuristic-systematic model 198–200 Hietala, P. 21–2 Hillberry, Russell 144–5 Hnatkovska, V. 10 Hofstede, G. 124 home assets 11 home bias 19, 26–7, 31, 40, 46, 50–1, 58, 144, 162–3; analysis of 19; asset-invariant 57; behavioral-based explanation for 61; behavioral factors see behavioral factors, home bias; corporate governance and transparency

Index 225 45–6; degree of 4; determinants of 158; deviations from purchasing power parity risks 5–13; empirical evidence of 163; in equities 1–3, 8; explanation for 13, 20, 44; facts and relationships on 4; ineffectiveness of 160; information asymmetries 35–44; information-based explanation of 44; in international financial portfolios 2; in investment/ consumption 16; levels 168; liabilities risks 13–20; literature on 137; nontradable assets risks 14–19; observed 46; phenomenon 7, 153; portfolios 4, 23, 44; in public procurement 158, 160; puzzle 2; risk aversion instability 45; of U.S. investors 36 home community 162 home country bias 47–8 home country investments 31 home-currency bias 138 home economy 16 home research community 162 Horioka, Charles 123, 134 horizon equilibrium model 37 hub-and-spoke systems 144–5 Huberman, Gur 47–8, 123, 126 human capital: for portfolio choice 14; return to 14; risk 18 human consciousness 99, 103–4 humanistic geographers 83, 85 human societies 203 Hummels, David 144–5 IAS see International Accounting Standards (IAS) IFRS see International Financial Reporting Standards (IFRS) imperfect international financial integration 39 Indian sellers in transactions 171 “indirect effect” of governance 46 individual consciousness 99 individual foreign equities 44 individual investors 41, 153, 167 individualism 124–5 individual portfolio holdings 29–35 individual stocks 23 Indonesia, equity investments 3 industrial proximity 137 inflation risk 6; control for 25; domestic 25–6 information: cultural patterns of 206; flow 125; gathering, cost of 124; processing of 128

information acquisition 125; nature of 133 informational asymmetries 35 informational barriers 45 informational costs 133 informational friction 35 informational heterogeneity 37 information asymmetries 35–44, 57, 124, 148, 154–5; criticism on 44; effects of 39–40; intensity of 124; models of 43; problems 153–4; proxy for 40; reduction in 31; transparency and 45 information-based relational loans 133 information-based synergies 148, 150 informed acquirer 148 institutional investors 21, 31 International Accounting Standards (IAS) 156 international borders 137, 143–4 international business 139–43; contracts 168 international capital: flows 24–5; markets 20, 44; mobility 135; turnover of 10 international CAPM 25, 46–7 international congresses 163 international consumption risk-sharing 6 international currency: bias 138–9; issuers 138–9 international diversification 28, 32–3, 47, 153; benefits of 1, 32, 35; extra cost of 35; investor from 35; potential benefits of 35 international economics 141 international economy, DSGE models of 4 international equity: allocations 19; trades 37; transactions 29; turnover rates for 29 international exchange puzzles 142 international finance 1, 122 international financial portfolios, home bias in 2 International Financial Reporting Standards (IFRS) 41 international financial transactions 135 international investment: barriers to 22, 46–7; for emerging markets 22; removal of barriers to 20–1 international investors 170 internationalization theory 140 international macroeconomics 2, 135, 143–4 international marketing 145–7; literature 145 International Monetary Fund 51 international nominal bonds 12 international portfolio 4, 38; allocation decisions 6, 123; decisions 23; holdings

226 Index 46; literature on 33; model of 21, 24; selection 153; theory 6 international presence 36 international relations theory 31 international risk-sharing 4 international specialization 158 international trade 143–5; data 141; in financial assets 1 international transactions 29 international underdiversification 50 interpretive paradigm 99; with respect to place 100–3 interpretive researchers 99 inter-regional foreignness 139, 141 inter-related scientific benchmark community 161–2 inter-state border effect 144 intra-regional trade 144 inventories 144–5 investment 134; choices 48; cross-border 170; in overseas markets 54; rate 123 investor 1, 4, 7, 41–2, 124, 137; beliefs 34; bond portfolios 137; characteristics 59; competence 52; domestic 47; familiarity 136; holdings 138; home market 136–7; individual 153, 167; international 170; from international diversification 35; local and distant 153; local equities among 126; objective function of 38; reactions 128; tendency for 2; trade 48; in United States 3 Irarrazabal, A. 141 iShare index funds 24 Jaffe, J. B. 148, 164–5 Jagtiani, J. 22 Janakiramanan, S. 21 Jannati, Sima 128 Japanese investors 53–4 Jermann, Urban J. 10, 15, 18 Jia, Chunxin 128 Jochec, M. 59 John Hancock–Gallup survey 49 Johnson, B. 162 Kang, Jun-Koo 136, 153–6 Kaplanis, Evi 2, 6 Kiesler, S. 161 Kilka, M. 54 Kim, Jin-Mo 153–6 knowledge 108; activation, social-cognitive principles of 199; based assets 148; flows, types of 163; macroeconomic models 163; nature of 93; systems of 205

knowledge spillovers 163; intensity of 164; nature and scope of 163–4; types of 164 Kollmann, Robert 3, 6, 8 Kraay, A. 3 Kraut, R. 161 Kuhn, T.S. 161–2 Lange, L. 163 La Porta, Rafael 127 Lauterbach, Beni 7 lenders 130 Lerner, Josh 154 LeVine, Robert A. 146 Lewicka, Maria 210–12 Lewis, Karen K. 3, 7, 12, 28 liabilities risks 13–20 Liberti, Jose M. 134 listing behavior 136 litigation-related decisions 168 loan: conditions 131; market 130–4; pricing 131; rates 131 local acquirers 149, 155 local currency 138–9 local equities 1 Losq, E. 21 loss aversion 60 loyalty 59 Lucas, Robert E., Jr. 4–5, 9 macroeconomic research 163 Maggiori, Matteo 137–8 Mahlck, P. 161 Malloy, Christopher J. 125–7, 148, 154 marginal utility 28 markets: capitalization 14, 42, 47; economy 151; inefficiency 131; loan/ borrower characteristics 130; price of home goods 16; production 12; vis-a-vis foreign 33 Marsden, P. 161 Martin, Philippe 24 Marxian theory 109, 113 Marxism 104 Marx’s theory of growth 109–10 Massa, Massimo 15 material transformation, process of 108 Matsumoto, Akita 17–18 Mayers, D. 14 Mayer, T. 141 McAfee, R. 159 McCallum, John T. 143–4 McMillan, J. 159 mean-variance framework 25

Index 227 mean-variance portfolio approach 24–8 mergers 40, 147–51; cross-border 153; regulations, role of 152–3; value creation in 149 Merton, R.C. 41–2 Mian, Atif 132–4 migrant communities 31 migrant networks, role of 143 Minkov, M. 124 Miyagiwa, K. 160 MNEs see multinational enterprises (MNEs) mobility, internalizing 209–10 modelling trade costs 141 modern portfolio theory 122 monetary authority 18 monetary policy 20 monoculturalism 198, 207 Montobbio, Fabio 165 moral values, principles of 146 Morgan, Gareth 92 Morse, Adair 128, 142, 153 Moskowitz, Tobias J. 123, 125–6, 136 multicultural education 205–6 multiculturalism 205–9; awareness 208; cross-cultural contact 207; cultural conflict 207; description of 205; disequilibrium 208; educational interventions 208; monoculturalism 207; process of 208 multinational enterprises (MNEs) 139–40 multi-state transactions 168 mutual funds 167; foreign allocation of 21; investments 148 mutual trust 142 NAFTA see North American Free Trade Agreement (NAFTA) narrow framing 60–1 national identity 145 nationalism 89, 152 nationalist government reactions 151 nationality: basis of 151; bias 170–1; of buyers 171 national market indexes 32 national saving rates 135 nature of society 93 negative bias 142 neighborhood 211–12 net equity flows 29 the Netherlands in domestic stocks 3 Neumann–Morgenstern utility functions 47 neutrality proposition 160

Nevill, A. M. 172 New York Stock Exchange 47 Nini, Greg 130–1 nominal bonds portfolios 19 non-behavioral explanations 47 non-diversifiable labor 18 nonlocal transactions 147 nonmarket production 11–12 non-price loan terms 130 nontradable assets risks 14–19 nontradable consumption 9, 12 nontradable goods, consumption of 10 nontradable income risk 17 nontraded asset 14 nontraded equities, returns of 10 North American Free Trade Agreement (NAFTA) 141 notion of contradiction 109 notion of crisis 109 notion of structure 109 notion of totality 109 “objective” trustworthiness 129 Obschonka, M. 165–6 Obstfeld, Maurice 2, 8–9, 13, 19, 122–3 Ongena, Steven 131–2 ontology 92–3 open economy macroeconomics 134 open economy models 134 Oppenheim, C. 162 optimal allocation 19 optimal distinctiveness theory 86 optimal portfolios 9; decisions 18; rule 25 optimism 53–4 Organisation for Economic Co-operation and Development (OECD) countries 3, 134 Orpurt, Steven 126 Osegowitsch, T. 140 overconfidence 55 overlapping-generations model 37 Pang, Ke 18 paradigms 91–2; diversity, benefits of 91 partial acquisition 155 partial-equilibrium problem 37 partial segmentation, implications of 21 Parwada, Jerry T. 167–8 patent citations 163–5; use of 164 “Patriot Bonds” 59 patriotism 55, 57–9, 124–5; country-level 153; documented importance of 57, 124 Patterson, Michael E. 90

228 Index peer comparisons 59 pension: funds 21; liabilities 19 people–place relations 94 Perri, Fabrizio 8, 15, 19 personal continuity 90 personal identity 108 personality: development 146; geographic changes in 166; role of 166 person-place bonding 82, 85 person–process–place framework 90 Persson, O. 161 Pesenti, Paolo 11 Petersen, Mitchell A. 124 physical place attachment 88–90 place: identity 83, 89, 96–7; management, justice and equity in 108; meaning, development of 87; physical characteristics of 89; realities 105; social and cultural values of 106; social construction of 106 place attachment 83, 125, 129, 202–5; as affect 85; application of 82–3; as behavior 87–8; behavioral expression of 87–8; bonds 90; as cognition 85–6; concept of 90; definition of 82–3; dimensions of 88–90; functionalist paradigm 94–9; individual and collective place attachment 83–5; interpretive paradigm 99–103; mobility on 209–10; multi-paradigmatic organizing framework 90–4; place dimension 88–90; psychological process dimension of 85–8; radical humanist paradigm 103–8; radical structuralist paradigm 108–13; research on 88; social and physical 88–90; study of 90; three-dimensional framework of 83; tripartite model of 84; tripartite organizing framework 82–3 place dependence 83; defined 97 place making: activities of 106; claims of 106 plausible investment strategies 33 Pogano, Marco 137 Polish investors 27 political attitudes 128 politics of place 107–8 Portes, Richard 137, 142 portfolio allocation 19; decisions 124 portfolio biases 15 portfolio decisions 16–17 portfolio holdings 122 portfolio managers 167 positive bias 142

positivism, tradition of 95 post-acquisition governance 155 potentiality 103 Poterba, James M. 2, 25, 122–3, 167 Povel, P. 148 PPP see purchasing power parity (PPP) Pradkhan, Elina 57, 124–5 preference bias 8 price/earnings to growth (PEG) ratio model 27 price/pricing 130; differences 130–1; loan 131; rigidity 17; stability 18; strategies 132; uncertainty 6 principal-agent theory 49 private information, importance of 150 private international law 168 probably reality 91 process information 38 pro-competition policy 152 procurement: contracts, allocation of 159–60; discrimination in 159; home bias 158–9; international disciplines on 160; literature 158–9; metrics 159 production, capitalist mode of 111 product markets 140 property right 164 prospective shareholders 156 protectionism 152 proximity 125; advantage of 147 proximity-maintaining behavior 87 psychological process dimension 82 public capital markets 156 public procurement: home bias in 158; office on 160 purchasing power parity (PPP) 5; deviations 6; inflation risk and deviations from 6; risks 5–14 pure code-law countries 157 purposive rationality 104 Pursiainen, Vesa 127–9; regression analysis 129 radical humanist paradigm 103–8; application of 104–5; with respect to place 104–8 radical structuralist paradigm 108–13 Rahbari, Ebrahim 18 Rajan, Raghuram G. 124 rational inattention 38 rationality 95 Rauch, J. 143 RBOC see Regional Bell Operating Company (RBOC) Real Capital Analytics 171

Index 229 real estate 170–1 real exchange rate risk 13, 18 realistic group conflict theory 146 reality creation process 103–4 referee bias 173 regional attachment 167 Regional Bell Operating Company (RBOC) 40, 47, 123 regional entrepreneurship 166 regional integration initiatives 141 regional personality differences 166 regulatory harmonization 141 reification 204 Reisman, Haim 7 relational financing 132 relational lending 132 relational loans 133 religion, commonality of 142 religious connections 84–5 research: traditions 90; types of 107 retailing 140 “return-chasing” effect 36 Rey, Helene 3–4, 9, 24, 137, 142 Richardson, J. 160 risk aversion 16; instability 45 risk aversion parameter 28–9 Rogoff, Kenneth 2, 9, 13, 122–3 Rugman, A. 139–40 Sammartino, A. 140 Sarkissian, Sergei 135–7 savings 134; investment 134–7; rate 123 scale, internalizing 210–11 Scandinavian scientific community 163 Scannell, Leila 83 Schill, Michael 135–7 scientific community 162; home nature of 161–3 scientific knowledge 99–100 segmentation 145 segmented capital markets 134 self-awareness 208 self-perceived competence 52 sell-side analyst 128 Seno-Alday, S. 140 sense of place (SOP) 95–6; approaches to measuring 97; attitude-based conception of 97–8; concept of 105; measurement models 98; method 98; results 98–9; social construction of 106; theory 97 Sercu, Piet M. 3 shareholders 45, 49; disclosure needs of 156

shares, domestic ownership of 2 Sharma, Subhash 146 Shimp, Terence A. 146 Shingal, A. 160 Shive, Sophie 128, 142, 153 Simonov, Andrei 15 simple mean-variance model 14 Singh, R. 148 size-dependent ability 138 smaller-sized firms 138 Smith, G. 6, 146 social interaction 89, 108 social networks, behavior in 161 social place attachment 88–90 social reality 99 social system, ideological superstructures of 104 social theory 91–2 sociocultural group 202 sociology of radical change 94 sociology of regulation 94, 99 soft information 150 SOP see sense of place (SOP) Sorenson, Olav 167 sovereign adjudication system 168 spatial bonds 89 spatial concentration 112 spatial expansion 112 spatial price discrimination 131–2 Spiller, P.T. 147 sport competition 171–3 standard finance theory 1 Stein, Jeremy 133–4 stock holdings 123–4 Stockman, Alan C. 9 stock market: fluctuations 61; indices 3; liberalization 23; response 152–3; wealth 2 stock returns 125 stocks, information on 41 Stokowski, P.A. 104–5 structural conflict 104 Stulz, Rene M. 136 subjective interpretations of individuals 99 subjective-objective dimension 94 subjectivity 99 substantial autonomy 132 super home bias 18 Sutherland, Alan 18 symbolic environments 202 symbols 203, 205 syndicated loan market 57, 124, 130; participants 131 synergy, potential source of 147

230 Index systematic bias 170–1 systematic differences in information 129 systematic processing 199–201 Taiwanese markets 126 target governance activities 154 target management 155; monitoring of 154 Tesar, Linda L. 2, 123, 137 Thailand, foreign investors in 22 Tirole, Jean 133–4 tradable equities 10 tradable goods 8, 10; demand for 10 tradable/nontradable equity 12 trade: geographic pattern of 144; macroeconomics literature 160; openness 16; protectionism 152 traded securities 14 traditional hypothesis testing 97 Trajtenberg, M. 165 transactions: announcement of 149; costs 23–35, 57, 124; fraction of 170; Indian sellers in 171; international 29; loans 133; prices of 171 transmission of information 148 transparency: corporate governance and 45–6; and information asymmetries 45; provisions on 160 transport/transportation 110; cost of 110–11, 131–2; facilities, structure of 112; means of 111; modes 145 Trionfetti,F. 158 trust 142; between countries 127; in cross-border financial investments 153; differences in 143; formation of 143; level of 142; toward citizens 58 underdiversification 24; costs of 26–7; economic costs of 29 unemployment 152 Uppal, R. 9 U.S. Commodity Flow Survey 144 U.S. corporate defendants 169 U.S. equity analysts 126

U.S. generally accepted accounting principles (GAAP) 41, 156 U.S. investors 1, 28–30, 128; bond portfolios 123; home bias of 36 U.S. markets, corporate loans 130 USPTO patent citations 165 U.S. stocks 3 Uysal, Vahap B. 147–50 value chain 145 Vanpee, Rosanne 3 van Wincoop, Eric 11, 13, 17 VAR model see vector autoregression (VAR) model vector autoregression (VAR) model 15 venture capital 154 Verbeke, A. 139–40 Vienna stock exchange 137 Wang, P. 161 Warnock, Francis E. 3, 123 Warren, Geoffrey J. 3 Weber, M. 54 Werner, Ingrid M. 2, 123, 137 White, H. D. 162 wholesale shippers 145 wholesaling 144–5 Williams, Daniel R. 90 wishful-thinking bias 54 Wolf, Holger C. 144–5 word-of-mouth effect 126 World Bank 169 world capital market 136 world equity capitalization 2–3 world market capitalization 47 world market portfolio 1–3, 46, 122 World Trade Organization (WTO), Agreement on Government Procurement 160 Yafeh, Y. 124 zero capital mobility 134 Zignago, S. 139, 141