Estimating the Costs of International Equity Investments

Abstract

Generalizing Cooper-Kaplanis ( 1994 ), we estimate implied costs that reconcile international portfolios with InCAPM predictions. Costs depend on home- and host-country characteristics and on interactions; we estimate risk tolerance rather than pre-specifying it; and we control for currency risk, inflation hedging, fixed-interest investments, round-tripping and omitted countries. Estimates for developed markets are lower than reported before, but those for new markets are quite high: 2001-2004 inward shadow costs range from 0.01 %p.a. (US) to 37 (Indonesia). We find that equity home bias is related to a mixture of risks and frictions, such as information asymmetries, institutional factors and explicit costs.