- Home Bias Abroad: Domestic Industries and Foreign Portfolio Choice
In their foreign portfolios, international mutual funds overweight industries that are comparatively large in their domestic stock market. This Foreign Industry Bias is akin to a "Home Bias Abroad". It is associated with superior performance primarily driven by stock picking within foreign industries by funds with a simultaneous Home Bias in their domestic portfolio. Their foreign trades co-move with global industry returns and predict foreign stock returns. This suggests that the domestic stock market composition proxies for the comparative advantages of international investors and supports the view that domestic industry information is portable and useful in foreign portfolio choices.
We study international outsourcing among asset managers and find that in companies that manage both outsourced and inhouse funds, inhouse funds outperform outsourced ones by 0.85% annually (57% of their expense ratio). We attribute this to outsourced funds "subsidizing" inhouse funds via the preferential allocation of IPOs, information and cross-trades, especially during times of inhouse fund distress. Subsidization serves as an implicit "in kind" incentive-based compensation. As theory posits, subsidization makes the subcontractor deliver higher performance, increases with the subcontractor's market power and the difficulty of monitoring the subcontractor, and decreases with the subcontractor's amount of parallel inhouse activity.
- Contagion and Decoupling in Intermediated Financial Markets
I analyze the interplay between fundamental and intermediation risk in a multi-asset dynamic general equilibrium model with heterogeneous agents. Agents differ in their level of direct access to investment opportunities. Intermediation relationships are formed to overcome limited market access. Intermediation risk is captured via frictions in the relationships between agents that introduce fragility into asset prices. Asset prices are fragile when they have a concentrated investor base making them dependent on the fortunes of a few investors. In contrast, a non-concentrated investor base makes asset prices resilient with respect to intermediation risk. But not all assets with a concentrated investor base are fragile. I identify fundamental characteristics that induce resilience in assets with a common concentrated investor base. These characteristics lead to portfolio rebalancing within the common investor base that makes some assets resilient and renders others fragile in the presence of intermediation risk. Likewise, in a multi-asset framework, assets that are resilient due to a broad investor base are not completely immune to the fragility experienced by other assets. In a dynamic context, fragile assets tend to experience contagion whereas resilient assets tend to decouple whenever the intermediation frictions are severe. I argue that an understanding of the dynamic behavior of asset prices requires an understanding of fundamental and intermediation risk as well as the interaction between the two.