Abstract

Financial theory suggests that, in order to reduce portfolio risk, investors should hold nationally and internationally well diversified portfolios. However, investors still overweight their portfolios with the domestic assets. This is referred to as ‘the equity home bias’. Many researchers tried to explain this phenomenon by using imperfections on capital markets such as transaction costs, asymmetric information, exchange rate risk etc., but they did not succeed in showing how financial decisions are truly made. This may be due to restrictive assumptions of capital asset pricing models. In this paper we present a survey of some effects of market imperfection on international portfolio choice as well as some limits of these models.

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