Information Advantage and Institutional Investors’ Performance in Foreign Markets

Traditional portfolio theory predicts that investors’ portfolios should be diversified across international markets. In contrast, empirical studies document that investors are more likely to invest in their home country and in familiar foreign markets. These findings imply that investors do not take advantage of international diversification opportunities. This study focuses specifically on foreign market asset allocations and examines empirically whether the familiarity driven foreign portfolio investment is a rational choice attributed to information advantage. Using a sample of over 46,000 institutional investors from 46 countries, we show that investors overweight foreign markets that are familiar but also earn higher risk-adjusted returns in those markets. Furthermore, we document that more skilled investors benefit the most from familiarity based allocations.