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Volume 6, Numbers 3 & 4
September / December 2002

Quarterly Publication of Multinational Finance Society • ISSN 1096-1879

Domestic versus International Portfolio Selection: A Statistical Examination of the Home Bias
(Multinational Finance Journal, 2002, vol. 6, no. 3&4, pp. 131-166)

Larry R. Gorman
California Polytechnic State University, U.S.A.
Bjorn N. Jorgensen
Columbia University, U.S.A.

The observed international home bias has traditionally been viewed as an anomaly. This paper provides statistical evidence contrary to this view within a mean-variance framework. Two methods of estimating the expected return and covariance parameters are investigated: (i) the traditional Markowitz approach, and (ii) the Bayes-Stein "shrinkage" algorithm. In-sample tests reveal that neither the Markowitz tangency allocation vectors nor the Bayes-Stein tangency allocation vectors are significantly different than a 100% domestic allocation (i.e. extreme home bias). These results are robust to the shorting of equity and across foreign exchange hedge strategies. The paper also reports out-of-sample tests with a view toward investment performance. Typically, a 100% domestic allocation outperforms both the Bayes-Stein and Markowitz tangency portfolios. Overall, the theorized gains to international diversification appear difficult to capture in practice and, hence, investors exhibiting a strong home bias are not necessarily acting irrationally (JEL F3, G11, G12, G15).

Keywords: efficient allocation, foreign exchange hedging, home bias, international allocation, portfolio.

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The Dynamics and Stochastics of Currency Betas Based on the Unbiasedness Hypothesis in Foreign Exchange Markets
(Multinational Finance Journal, 2002, vol. 6, no. 3&4, pp. 167-195)

Winston T. Lin
State University of New York at Buffalo, U.S.A.
Hong-Jen Lin
State University of New York at Buffalo, U.S.A.
Yueh H. Chen
National Sun Yat-sen University, Taiwan

This article examines the dynamic and stochastic behavior of the beta coefficient (to be referred to as the currency beta) of the unbiasedness hypothesis (UH) in foreign exchange markets. We argue that the dynamics and stochastics of currency betas can be attributed to the dynamic behavior of various macroeconomic variables from different sectors of an economy, in addition to the trend variable considered in previous research. Incorporating four macroeconomic variables from the financial, real, and external sectors into the currency betas of eight currencies (developed and emerging) under a logarithmic change specification used to test the UH, we attempt to simultaneously test the behavior of currency betas in terms of nonstationarity, shifts in the mean and variance, and randomness. The vast quantity of empirical tests and results strongly suggests that the changing characteristics of currency betas are readily apparent and have important implications for the reconciliation of the controversies surrounding the legitimacy of the UH, for government exchange rate policies, and for the forecasting of future spot rates, across the developed and emerging economies under study. We also find different tales from developed and developing countries (JEL F31, F37, F47, G15).

Keywords: four-step generalized, logarithmic change specification, macroeconomic variables, unbiasedness hypothesis, variable mean response

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The Information Content of Earnings on Stock Prices: The Kuwait Stock Exchange
(Multinational Finance Journal, 2002, vol. 6, no. 3&4, pp. 197-221)

Rashid Al-Qenae
University of Kuwait, Kuwait
Carmen Li
University of Essex, UK
Bob Wearing
University of Essex, UK

This paper investigates the incremental information content of earnings and other macroeconomic variables for share prices within the ‘prices leading earnings’ framework. We find evidence supporting the phenomenon of ‘prices leading earnings’ for the Kuwait Stock Exchange (KSE) after controlling for basic macroeconomic indicators. That is, the estimated earnings response coefficient is found to be sensitive (and significant) to the leading periods and it increased when more leading periods were included. The results suggest that prices anticipate earnings and hence provide useful information to KSE investors (JEL G140, G150, O160).

Keywords: earnings response coefficients, Kuwait Stock Exchange, price-leading earnings.

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The Sensitivity of European Bank Stocks to German Interest Rates Changes
(Multinational Finance Journal, 2002, vol. 6, no. 3&4, pp. 223-249)

Simon Stevenson
University College Dublin, Ireland

This study examines the cross-border impact of central bank interest rate changes, using the example of the German Bundesbank. We examine the price impact of rate changes on both the general stock markets and on bank stocks in seven other European countries. The sample includes nations both within and outside of the European Union, and includes EU members who are participating in monetary union and members who obtained opt-outs. The results point to the existence of cross-border information transfers. Both non-German bank stocks and general equities react significantly to a large number of the Bundesbank rate changes. The results also indicate that European capital markets did differentiate between rate changes in terms of their relative importance. This was the case in terms of different responses between the financial institutions and the general equity markets and with regard to differing reactions between markets. In particular, those markets that were more committed to the exchange rate mechanism and the goal of monetary union generally reacted more than markets such as Denmark and UK. In addition, the importance of Bundesbank policy during the years leading up to EMU is supported by the fact that most non-German bank stocks reacted more to Bundesbank policy than to domestic rate changes and that no other country had the same level of influence on foreign equity returns (JEL E44, E58, F33, G15, G21).

Keywords: bank interest rate sensitivity, cross-border information transfers.

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