The Effects of Strict Social Norms on Home Bias

Despite the documented advantages of international portfolio diversification, investors tend to over-allocate to domestic markets, leading to exposure to home bias. This paper explores the behavioral explanation of this phenomenon by investigating the relationship between cultural tightness-looseness and equity home bias. Based on foreign portfolio holdings data from 28 of the most developed markets and over the period 2001-2022, we find empirical support using the OLS methodology that investors from culturally tighter countries register higher levels of home bias, compared to investors from looser countries. In cultures where stricter social norms are imposed and little deviation is allowed, investors exhibit higher confidence in domestic returns and associate international investments as more costly. Due to higher levels of innovation and fewer behavioral constraints, investors from looser countries overcome the cost associated with the unfamiliarity of foreign stocks, managing to better diversify their portfolios internationally. Additionally, we identify that financial education and economic openness of the investor country alleviate the effect stricter norms have on home bias. The significance of the study is reinforced by the robustness tests performed, such as employing alternative measures of both our dependent and independent variables and testing the identified relationships through different estimation methods. This paper contributes to the extensive literature on home bias by identifying the strictness of social norms as a key cultural determinant in shaping international portfolio allocation and exploring channels to mitigate its effect on home bias.