Patriotism in Your Portfolio

Adair Morse and Sophie Shive∗

May 9, 2003

ABSTRACT

More patriotic countries and more patriotic regions within the United States hold

smaller foreign equity positions, in the time series and cross section of our data.

The patriotism effect is robust to controls for transaction barriers, risk, and infor-

mation, which constitute the standard explanations for home bias. Adding patrio-

tism explains 12% in the variation of foreign holdings across countries. Economic,

political, and social correlates of patriotism do not explain the effect of patriotism

on the home bias. We estimate that patriotism is responsible for approximately

9-21% of the U.S. home bias and 7-17% of the Canadian home bias.

∗Doctoral Students, University of Michigan Business School Department of Finance. Correspond-

ing author: Adair Morse, 701 Tappan Street, Ann Arbor, MI 48109-1234. Tel. 734-846-0057 Fax.

734-647-8133 E-mail adairm@umich.edu. We wish to thank Geert Bekaert, Sugato Bhattacharyya,

Anusha Chari, Artyom Durnev, Herman Kamil, Han Kim, Linda Tesar, Anjan Thakor, Nejat Seyhun,

Parker Shelby, Tyler Shumway, Lu Zheng, Luigi Zingales, and seminar participants at the University

of Michigan’s Departments of Economics and Finance for their valuable comments.

Why do people invest close to home? The phenomenon of observed over-investment

in home markets appears in a numerous incarnations: over-betting on the home sports

teams, over-allocating 401(k) choices to the employer’s stock, and over-investing portfo-

lios toward domestic assets.1 The over-investing in home markets is a puzzle for economic

theory in that well-behaved mean-variance optimizers would normally allocate invest-

ment in proportion to each asset’s risk-return characteristics. Observed behavior is not

consistent with diversification theories. Furthermore, an optimizer who has a personal

interest in a home victory, in the success of her employer, or in the growth of her country

should hedge possible under-performance by betting on the opposing team, shorting the

employer assets, and allocating more assets abroad. Such hedged allocations are rarely

observed.

The existing literature introduces three principal explanations for home bias: transac-

tion barriers, risk, and information asymmetries. A simple explanation has been largely

omitted. Could it be that investor sentiment toward the home country explains part of

the equity home bias? For many, the thought of betting against a home team or shorting

one’s company’s stock and country’s market index may seem awkward. Such would be

representations of sentiment-driven biases. Sentiment toward the home country is the

defining characteristic of patriotism. With the purpose of exploring the role of sentiment

on investment, we test the theory that patriotism can explain a portion of the observed

portfolio selection bias by examining whether the equity home bias is greater for more

patriotic nations.

The economic significance of patriotism has not previously been examined, yet anec-

dotal evidence suggests that patriotism influences investment decisions. We were moti-

vated to study this issue following the events of September 11, 2001. After the terrorist

attacks on Washington and New York, the stock markets remained closed for a week. In

the interim, much speculation ensued as to how far the market would drop; the media

1The sum of the disproportionately large allocation of a country’s aggregate equity investment todomestic assets is known as the equity home bias.

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advocated that patriots of the country should not sell their stocks upon re-opening of the

market.2 In the subsequent months, patriotic calls shifted to encouraging a re-buying of

stocks. In a November, 2001 Spectrem survey of affluent investors, 52% of respondents

said they would show their patriotism by making investments in U.S. companies.

Why are the patriotic actions of investors significant for the market? The implica-

tions of diversification biases are especially important, since undiversified investors take

unsystematic risk. If a large enough group of investors holds an undiversified position,

the bias may be priced by the market. The notion that investors might heed the call to

patriotic behavior has a clear implication; it seems that patriotism may affect markets.

The contribution of the paper is to explore the role of patriotism in explaining the

equity home bias. Our hypothesis is that more patriotic investors will choose to invest

more of their portfolio at home. In that the effect of patriotism is not in conflict with the

existing explanations, our aim is to assess whether patriotism can significantly explain

variation in foreign equity holdings after controlling for the effects of existing theories.

To test the hypothesis, we use a patriotism measure from the World Values Survey,

conducted by the University of Michigan. The survey asks individuals in 53 countries

whether they are proud to be a resident of their country. Using the average scores to this

question as a measure of patriotism, we show that patriotism is significant in explaining

the weight of foreign equities in the residents’ total equity holdings. A one standard

deviation change in patriotism decreases foreign equity holdings 4%. To control for

endogeneity, patriotism instrumented by percentage of rural population is estimated.

In instrumented results remain significant, and a one standard deviation in patriotism

decreases foreign equity holdings 2%. The significance of patriotism remains after inclu-

sion of controls for the other explanations for home bias. We find some support for risk

and information explanations in our panel, and we find strong support for the trans-

action barriers explanation. After controlling for all of the standard explanations for

2A November 1991 article in Money criticizes the call for a ‘patriot rally’ to prop up the market onthe day it re-opened after the terrorist attacks of September 11, 2001 (Frederick, 2001).

2

home bias, both patriotism and instrumented patriotism explain 12% of the variation in

foreign equity holdings.

To test the robustness of this finding, we consider a within country sample and a

first differences specification. For nine U.S. Census regions, higher patriotism scores

are associated with lower foreign holdings. In the cross-country data, a first difference

across survey years shows that greater increases in patriotism are accompanied by lower

positive changes in foreign holdings.3

It is possible that correlates of patriotism could be driving its effect. We explore vari-

ables capturing economic, political and social correlations with patriotism. For upper

income respondents of each countries, patriotism is most correlated with greater income

disparity, more reported crime, higher trust of the government, less need for discussing

politics, and higher charitable and religious inclinations. These correlates do not negate

the significance of patriotism when included in the full model regression of foreign hold-

ings on patriotism and the standard explanations for the home bias. Charitableness has

explanatory power on foreign holdings beyond its role in patriotism. To test the ro-

bustness of our results, we investigate whether patriotic feelings might be endogenously

determined by past country performance. We find no reduced significance of patriotism

when controlling for past performance. Finally, we estimate that patriotic behavior is

responsible for 9-21% of the U.S. equity home bias, and 7-17% of the Canadian home

bias. We conclude that investor sentiment has a non-negligible role in an individual’s

tendency to invest in the home market.

The remainder of the paper is organized as follows. Section I discusses why investors’

patriotism can affect their equity holdings. Section II introduces our measures of patrio-

tism and of the equity home bias. In Section III our main results are presented showing

patriotism significant in explaining the home bias. Section IV contains a variety of ro-

bustness tests, including tests on the correlates, instrumented patriotism, alternative

3Both of these tests are informal as the data are severely constrained.

3

measures of the explanations, and investor protection explorations. The last section

concludes.

I. Why Might Patriotism Affect Foreign Holdings?

Why might patriotism affect foreign holdings? Patriotic investing is an old and widespread

phenomenon. In the United States, the promotion of war bonds using patriotic rhetoric

dates back at least to the Civil War. To finance the Union effort, the U.S. government

sold war bonds with names and distribution tactics that appealed to the patriotic call.

Since then, the U.S. government has used war bonds to generate cash during times of

country hostilities. For example, after the September 11th attacks, Series I and EE Trea-

sury Bonds were dubbed ‘Patriot Bonds’, and in 2001, their sales rose to $ 6.6 billion, a

43% increase over the previous year (Sulon, 2001). While appeals to patriotism appear

to encourage investment, no study has tested the economic impact of patriotism.

French and Poterba (1991) and Tesar and Werner (1995) empirically document that

investors’ domestic holdings are very high. French and Poterba calculate that U.S.,

Japanese and U.K. investors held 94, 98 and 82 percent of their portfolios in domestic

assets. If one were to take the CAPM literally, each investor would hold the world market

portfolio, thus holding all stocks in proportion to their market capitalization. Taking

into account human capital, which follows the country’s fortunes, investors should invest

even less in their home country (Baxter and Jermann, 1997). Pastor (2000) calculates

that U.S. investors’ belief that their home market is as mean-variance efficient as the

world market (it is not) must be extremely strong to justify the home bias in their

equity holdings. It is not surprising that Obstfeld and Rogoff (2000) categorize the

home bias as one of “the six major international macroeconomics puzzles”. Grinblatt

and Keloharju (2001) find that Finnish investors prefer stocks of Finnish firms, especially

those that communicate in their own language and are operated by Finnish executives.

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While this is consistent with investors’ possessing additional information about firms

that communicate in one’s own language, it is also consistent with patriotic investing.

No previous study has explored the equity home bias in a behavioral light, although

two closely related puzzles lend themselves well to behavioral theory. We briefly describe

the role of ‘patriotism’ in the sports betting market and in the 401(k) asset allocation

choice. Consider the (illegal) sports betting market and the case of a non-professional

better. If the better is risk averse, expected utility theory predicts that she will hedge

the possibility of low utility from a home team loss by betting on the opposing team.

Contrary to this prediction, individuals tend to bet on their home team, even with un-

favorable odds (Gray and Gray, 1997). Strumpf (2003) observes that illegal bookmakers

charge extra for home team bets to compensate for the additional risk they incur due

to the home bias of their clients. The same betters may be willing to bet on their own

country’s stocks, even with unfavorable returns.

A second related puzzle is the pattern of 401(k) portfolio allocations. People invest

disproportionate amounts of their discretionary 401(k) retirement assets in their own

company’s stocks. For example, Bernartzi (2001) finds that the retirement fund of

Coca-Cola allocated 90% of its value to the firm stock, and employees themselves allocate

76% of their discretionary contributions to Coca-Cola shares. Although a typical large

company is twice as risky as a diversified portfolio, John Hancock Financial Services

(1999) reports that a majority of employees feel that their own company stock is safer

than a diversified portfolio, and only 18% realize that their stock is riskier. In a similar

study, the Vanguard Group (2001) reports that participants see ‘individual stocks’ as

more risky than a diversified equity fund, and their own company stock as less risky.

In a survey conducted by Bernartzi (2001),4 only 16.4% of respondents believed that

their company stock was more risky than a diversified portfolio. This practice strongly

contradicts mean-variance theory; the observed 401(k) allocations fail to diversify away

4This can be found on Morningstar.com.

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a firm’s unsystematic risk. Even worse, the employer stock is the asset most correlated

with the employees’s human capital, and thus a rational agent should short employer

stock, not hold large quantities of it.

Both utility and behavioral theory can help us understand the home team bias, the

401(k) bias, and the equity home bias. First we consider traditional utility theory. If

the future is not fully discounted and if capital flow is somewhat constrained across bor-

ders, then investing at home may bring future material benefits, such as jobs, improved

infrastructure,5 and benefits from the taxes paid by corporations on the same soil. The

anecdote below highlights the relevance of this point.

A large central bank in an emerging market brought in a new director of thepension fund department who was to choose the portfolio allocations for thefund. After studying the portfolio, the new director approached the headof the central bank with an optimal international diversification strategy.The central bank head quickly rejected the plan, retorting that the fundinvestment was not to leave the country; the country needed the capital forgrowth.

Investment in the home market might generate intangible utility such as the approval

of others and the feeling of contributing to society. It may also reduce regret if the

investment has low or negative returns. If monetary and non-monetary benefits outweigh

diversification benefits, biased investment strategies are rational. Otherwise, they must

be due to an irrational influence. In the case of home team betting, the benefits must be

emotional because the money wagered cannot affect the outcome of the game. According

to Kahneman and Lovallo’s (1993) ‘inside view’, insiders may strongly identify with an

organization and may find it difficult to hold an independent view on the expected

returns to company stock, and investors may have similar trouble evaluating their home

market objectively. An inside view could either elicit overestimation of the mean return

5Huberman (1997) shows that people invest a large portion of their portfolios in their local phonecompany.

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(optimism)6 or underestimation of the associated risk (overconfidence)7. Of course,

the inside view allows only for such biases toward the entity with which an individual

identifies.

II. Measuring Patriotism and the Equity Home Bias

Patriotism: Love of country; devotion to the welfare of one’s country; the

virtues and actions of a patriot; the passion which inspires one to serve one’s

country.

- Websters’ Dictionary

Measuring patriotism is difficult because its definition is broad, and measures of

individual’s emotions are scarce. The patriotism data come from the University of

Michigan’s World Values Surveys conducted during two periods, 1990-1992 and 1995-

1997.8 Appendix A highlights details of the survey methodology and questions posed.

To measure patriotism, we focus on individuals’ responses to the question:

How proud are you to be [substitute nationality]?

Our measures of patriotism are mean country scores, averaged over individuals’ re-

sponses from 1 (not patriotic) to 4 (very patriotic). Since the more affluent account for

6Tesar and Werner (1995) find that the lack of diversification due to the home bias can be explainedby a 620 to 800 basis point over-estimation of domestic returns. Optimism can feed on itself; investorscan be convinced that their home market is superior and selectively ignore contradictory evidence(cognitive dissonance).

7Overconfidence is explored for example in Odean, (1999) and Barber and Odean, (2000). The “illu-sion of control” (Langer 1975), in which people treat chance events as controllable, may cause investorsperceive lower risk due to their influence on the outcome. There is also evidence that overconfidenceincreases with familiarity (Heath and Tversky 1991).

8The span of years reflects the time range in conducting the survey. Since the majority of countriesin our sample for the first survey range were surveyed in 1990, we use 1990 as the base year for the firstseries. For the second survey, we use 1996 as the base year, reflecting a median and mode of the surveyyears.

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the majority of stock holdings, we filter the responses to reflect only the upper half of

income earners in each country.9

Table 1 lists the patriotism scores for the two survey time periods, from which we

can draw some key insights. The table is arranged in increasing patriotism order for the

countries in Survey 1 (1992-1993) and Survey 2 (1995-1997). The mean score increased

marginally form 3.21 to 3.30.10 A systematic bias in the pattern of patriotism scores is

not evident in the sample. The 1990-1992 survey does suggest that New World countries

are more patriotic than Old World countries, but the larger 1995-1997 survey results are

more diverse within income and location groupings. It is clear that Western European

countries are less patriotic relative to the rest of the sample.

Our objective is to use the patriotism score to analyze the home bias, specifically

asking whether patriotism predict how much foreign equity each country’s nationals hold

in their total portfolios. The foreign equity holding variable is a weight of foreign equities

in a country’s aggregate equity portfolio. In other words, foreign equity holdings is the

percentage of a residents’ total equity portfolio that is invested abroad.11 We calculate

a weight of foreign holdings relative to total holdings (FEH) as follows:12

FEH =Foreign equity holdings

Market capitalization + Foreign equity holdings − Foreign equity liabilities

Data limitations in the survey and in the availability of foreign holdings restrict our

sample to 29 countries, six of which have data for both 1991 and 1996, resulting in 33 data

points all together. We were concerned that the availability of foreign holdings data was

biased toward large countries. Thus, we perform a Heckman selection test to determine

9In the United States, only 24% of wage earners under $30,000 held stock and 84 percent of Americanswith income over $75,000 hold equities (Langer, 2001). Clearly, the divergence grows even larger forpoorer countries in which disposable income for the poorer half of the population is limited. In theempirical results that follow, the use of the upper income mean of patriotism slightly improves ourresults relative to the full sample mean, but does not change the significance of the patriotism variable.

10For countries participating in both surveys, the average patriotism score increased form 3.25 to3.38.

11Appendix B provides sources for all the variables used in the study.12Our results remain if we simply normalize foreign equity holdings by market capitalization.

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if the selection of countries explained by GDP or market captialization is exogenous to

the estimation of foreign holdings on patriotism. We fail to reject that country selection

is independent of GDP and market capitalization with respective p-values of 0.94 and

0.13.

This study is biased against finding evidence of patriotic investing, because we test

the hypothesis that investors are only patriotic about their own country, not about

a region or a common market of countries. Since we examine total foreign outward

investment, and not toward which countries the outbound investment is aimed, we do

not determine if citizens are simply investing in a country’s close allies.

Two interesting possibilities arise if we find no relation between patriotism and foreign

equity holdings. The first possibility is that people’s portfolio decisions are not swayed by

emotion towards their country. Since patriotism affects other decisions such as careers

and purchases, and studies in behavioral finance have shown that sentiment affects

investment decisions, this would be an interesting finding. The second possibility is that

patriotic people invest not only in their country but also in the group of countries that

they consider ‘friendly’. Equity cross holdings data would allow us to test which of these

hypotheses is correct. In the next section, we present the patriotism and foreign equity

data and show our key result that patriotism is significant in explaining the panel of

foreign equity holdings.

III. Empirical Results

A. Panel Results

The central finding of the paper is depicted in Figure 1, a plot of the foreign equity

holdings against patriotism. This figure suggests a decreasing linear relation between

pride-patriotism and foreign equity holdings. Patriotism declines as foreign equity hold-

9

ings increase. To support this claim, a simple regression including a dummy for the

1995-1997 survey period shows that patriotism is significant in explaining foreign in-

vestment, with an R-square of 0.22. The result appears as the first regression on Table

II.

Following the terrorist attacks of September 2001, the Boston Globe related a story

of an individual who “wondered what would happen ‘if every red-blooded American...

bought a few shares of their favorite stock on Monday.”13 We test the economic signifi-

cance of our findings. According to our regression coefficient which is very stable across

specifications, a one-unit rise in the patriotism score will cause the foreign holdings in

the total equity position to rise by approximately 11 percentage points. To compare this

to the equity home bias, note that the optimal CAPM portfolio consists of equity in all

countries in proportion to their market capitalization. For example, in 1996 the United

States comprised 33% of the world market capitalization. However, it held 93% of its

equity at home. The difference, or home bias, is 60 percentage points. If, on a scale

from 1 to 4, we can assume that 2.5 is a neutral answer, our regression results estimate

that if the United States were to have a neutral patriotism score, the home bias would

be reduced by 0.16, (a 27% reduction). We are cautious in drawing too much inference

from this result before we explore other explanations.

In the remainder of this section, we control for other variables which may be influ-

encing the source of foreign holdings decisions.

B. Standard explanations for the Home Bias

Four main explanations have been proposed for the equity home bias. The first is that

transactions barriers make it difficult to invest abroad. A second set of studies suggest

that differences in the availability of information explains the home bias. Another line

13The Boston Globe, September 18, 2001

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of work considers additional risk that may come from investing abroad, potentially out-

weighing diversification benefits. We present our principal variables here, and perform

robustness checks by including other variables in the following section.

B.1. Transactions Barriers

Transaction barriers should negatively affect foreign investment, somewhat like a tax

paid on the absolute value of the holdings of foreign stocks (Stulz, 1981). Unfortunately,

measures of barriers to outward flows or inward repatriation of capital gains and divi-

dends are limited. Hence, we seek measures which may be highly correlated with foreign

equity holdings facilitation.

Chari and Henry (2002) show that when a capital-poor country is liberalized, there

is an infusion of capital from abroad, supporting the theory that liberalization allows

investors to allocate capital optimally between countries. Since liberalizations allow

capital to flow in both directions, the more liberalized countries’ nationals may be more

likely to invest abroad. In studying the effects upon market growth, Bekaert and Harvey

(2000) collect financial liberalization dates of emerging countries. Since all countries in

our sample were ‘liberalized’ by the first survey’s date according to this paper, we use a

dummy variable for capital account liberalization from the IMF Exchange Arrangements

and Exchange Restrictions Annual Report.14 Additional details for these variables ap-

pear in Appendix A. Although our hypothesis is that foreign holdings should decrease

with transactions barriers, it is well known that transactions barriers are likely not the

entire source of the home bias (Cooper and Kaplanis 1994, Tesar and Werner 1995, Er-

runza, Hogan and Hung 2000, Glassman and Riddick 2001 and Fourth, Ahearne, Griever

and Warnock 2001).

14A measure of tariff and non-tariff barriers from the Economist Intelligence Unit (EIU) databaseyields similar results

11

Our regression results appear in Table IV. The coefficient on transactions barriers

is positive and significant. When we add patriotism to the model, both patriotism and

transaction barriers remain significant. We infer that patriotism is an effect separate

from transactions barriers. The low R square on the single variable equations suggests

that transaction barriers alone are not the complete source of home bias, but barriers

appear somewhat economically significant. Table III shows the estimated change in for-

eign holdings for a one standard deviation change in other variables that are significant

in explaining foreign holdings. According to this table, a one-standard deviation change

in the IMF capital account restrictions would change the home bias by 5.5 percent-

age points. Adding transactions barriers to a model with patriotism and variables for

information and risk model improves the R-square by .128.

B.2. Information

Several studies find that differential information about securities contributes to the home

bias.15 Brennan and Cao (1997) develop a model of international equity portfolio in-

vestment flows and show that differential information endowments among investors con-

cerning equity knowledge can affect their investment decisions.

Bhattacharya and Groznik (2002) find that U.S. investment in a particular foreign

country is positively related to the income of the immigrant group from that country liv-

ing in the U.S. Bhattacharya and Groznik infer that immigrants have more information

about their home countries. Information effects are difficult to decipher; the authors

find that the level of investment in foreign countries is unrelated to language or physical

distance, which are the core components of distance gravity measures. It seems that

information regarding investments across borders is not merely a matter of closeness,

but rather a matter of specific country knowledge. Our information results are consis-

15See Huberman (1999), Choe, Kho, and Stulz (2000), Froot, O’Connell and Seasholes (2000), Covaland Moskowitz (1999),(2001), Grinblatt and Keloharju (2001) Bhattacharya and Groznik (2002)

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tent with this categorization of information as well. However it is worth pointing out

that Bhattacharya and Groznik’s results are also consistent with our patriotism claims.

Immigrants may invest in their countries of origin if that is where loyalties lie.

There has been strong support for the information hypothesis for studies of U.S.

and international investment. To name a few, Coval and Moskowitz (2001) show that

mutual funds earn abnormal returns when they invest in nearby firms. This effect is

more pronounced in small firms that operate out of remote locations, suggesting that the

mutual fund managers have an informational advantage when they invest in these firms.

Choe, Kho, and Stulz (2000) find that in Korean data from 1997 to 1998, domestic in-

dividual investors have a short-lived private information advantage for individual stocks

over foreign investors, but almost no evidence that domestic institutional investors have

such an advantage.

Information about a stock may aid in an understanding of the parameters of the

returns model and of the uncertainties inherent in the model. The comfort of feeling

trust in domestic institutions closely resembles a set of behavioral findings that people

dislike ambiguous situations.16 In particular, people underweight choices of which they

have difficulty understanding the distribution of outcomes.17 We do not attempt to

distinguish between the two explanations related to information: preference for reduced

ambiguity (model risk), and the possession of true information (knowledge about the

model parameters).

To proxy for the information that may be conveyed about foreign firms through the

media, we use the commonly used measure of newspaper circulation per capita 18. We

choose this variable because newspaper circulation is likely to have a similar effect for all

countries, contrary to televisions and internet which may have been scarce ten years ago

in some countries. Table II shows that number of newspapers per capita is significantly

16These findings are summarized by Barberis and Thaler (2002).17Heath and Tversky (1991)18Number of televisions per capita yields the same results

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and positively related to foreign equity holdings. When we add patriotism to the model,

both remain significant and the coefficients do not change much, suggesting that both

information and patriotism are important in explaining the home bias.

B.3. Risk

An investor may choose to invest abroad to mitigate financial risk. An international

portfolio may provide diversification, although the benefits are not clear because corre-

lations between countries tend to increase in bear markets. Consistent with the CAPM,

we predict that nationals of countries with high financial risk and low correlations with

the world portfolio will choose to invest more abroad, other things equal. Contrary

to this prediction, we find that correlation with the world index is positively related

to foreign holdings. This is likely due to the fact that countries which are integrated

tend to invest more abroad. Table VI shows that a one-standard deviation change in

the correlation with the world would change foreign equity holdings by 5.5 percentage

points. A one standard deviation change in diversification benefits changes our measure

of foreign equity holdings by 3 percentage points. Other variables that proxy for risk

are presented in the Robustness section.

C. Within-Country and Time Series Results

To further investigate the role of patriotism on foreign equity holdings, we study the

six countries that are present for both surveys in our sample. Our hypothesis is that

when patriotism rises, foreign ivestment decreases more (or increases less) than instances

when patriotism falls. Since our data constraints inhibit formal statistical tests, we

simply plot changes in foreign equity holdings against changes in patriotism. Figure 2

shows that while there are only six countries in the sample that have data from both

surveys, foreign investment falls when residents become more patriotic. The figure also

14

suggests that increasing globalism and increasing patriotism characterize the period

between the 1990-1992 survey and the 1995-1997 survey. Germany is the exception in

its decrease in patriotism, potentially because of the economic strains from unification

during the period. The striking result is that even though the entire sample globalized

their portfolios to some degree, Figure 2 shows clearly that countries who experience

more growth in patriotism had less globalization of their portfolios.

We have presented initial results across countries for points in time and across coun-

tries across time. Would patriotism explain portfolio variation within countries? Al-

though we are again data constrained, we obtain patriotism data from the 1995-97

World Values Survey for nine regions in the United States and compare them to foreign

equity holdings reported in the 1997 Survey of Consumer Finances. Since it is difficult

to find household net worth data for these regions, we use household income as a proxy

and normalize foreign holdings by this figure. The results are plotted in Figure 3. The

figure shows that the more patriotic regions of the United States – West South Cen-

tral, Mountain and West North Central – invest the least in foreign equities. Although

one cannot draw statistical conclusions from nine data points, the results support the

hypothesis that even within a single country, more patriotic investors are more home

biased in their investments.

To summarize this first analysis, we find that foreign holdings are inversely related

to patriotism, and investigate whether the patriotism results holds in the presence of

the the standard explanations for the home bias. In the following section, we consider

some tests of the robustness of our results.

IV. Robustness Tests

This section considers some correlates of patriotism that may be behind its effect. Next

we explore whether a common variable explains both patriotism and foreign invest-

15

ment holdings. We also test for the robustness of the patriotism variable against other

measures of transactions barriers, risk, and information. Last, we consider the role of

corporate governance. We find that these tests do not negate the effect of patriotism on

the home bias.

A. Correlates of Patriotism

We investigate what factors relate to a country’s patriotism score. Then, we consider

whether any of these factors drives the patriotism-foreign equity holdings result displayed

in Figure 1. We distinguish three types of possible correlates of patriotism - economic,

political, and social - and examine which ones are significantly related to our patriotism

score.

First we explore factors that may affect residents’ patriotism for economic reasons.

We expect patriotism to decrease with income disparity; high inequality, especially if the

inequality resulted in poverty at the low end, may be viewed as the ineffectiveness of the

state. We use income disparity as measured by the Theil Index from the University of

Texas. We also consider GDP per capita. Partial correlations are reported in Table IV.

Controlling for the survey year, both income disparity and inequality are significantly

correlated with patriotism. Regression results are presented in Table V. Since our data

points are limited and since the variables are all collinear, we only run patriotism against

each variable alone. We find that more income disparity is indicative of more patriotism.

This result is surprising; the ex post intuition is that the upper half of populations are

more patriotic for the populations who have advantaged the most. In other words, since

our measure of patriotism is confined to the upper income half of every population, it

may be that where disparity is high, the upper income groups are benefitting most from

the government and thus are more patriotic.

16

Next, we explore four possible political correlates to patriotism. All of the political

correlates have significant explanatory power. The first two political correlates to patri-

otism are the levels of crime and corruption. Presumably a country with low crime and

corruption levels will have more patriotic residents. Our measure of crime,the number

of murders, robberies or other violent crimes per 100,000 households, is taken from the

1995 World Competitiveness Yearbook. The corruption index is from the Internet Cen-

ter for Corruption Research, University of Goettingen and Transparency International.

Two other possible political correlates to patriotism are from the World Values Survey.

Responses to ‘How much do you trust your national government?’ and ‘How often do

you discuss politics at home?’ capture faith and interest in national politics, respec-

tively. In the latter case, however, a converse argument could be made that political

discussions may be enhanced by a dissatisfaction with the government in power.

Table IV reports that more crime and more corruption are indicative of higher pa-

triotism. The positive association between crime and patriotism remains even after

controlling for country per capital GDP. Corruption is negative and no longer signifi-

cant after including GDP in the regression. We posit that this result may be due to

increased reporting of crime resulting from better law enforcement, or it may be a sign

of economic freedom. Trust of government is positively correlated to patriotism (those

who trust their government tend to be more patriotic); however, the unreported par-

tial correlation is not significant. Discussing politics is significantly negatively related

to patriotism, meaning that those who frequently discuss politics at home tend to be

less patriotic. The inference is that more discussions of politics might be related to

discontentment with the governing powers.

Three possible social correlates to patriotism are the involvement of citizens in char-

itable organizations, the importance of religion, and ethnolinguistic fractionalization

within the population. The first two variables are from the World Values Survey, and

the third is from Easterly and Kraay (1999). Ethnolinguistic fractionalization increases

17

with the number of ethnic groups and languages within a country. We expect more char-

itable and religious populations to be more patriotic, and we expect ethnically diverse

populations to exhibit more loyalty to communities and less national patriotism.

The social section of Table V presents the regression results of patriotism on social

correlates. All of the social correlates are highly significant. More charitable and more

religious people are also more patriotic. Contrary to our prediction, higher ethnolinguis-

tic fractionalization is correlated with higher patriotism. In our sample, ethnolinguistic

fractionalization is correlated with New World Countries. It is unclear whether entholin-

guistic fractionalization is itself the attribute driving this association.

Given that several variables are correlated with patriotism, we are interested in know-

ing whether any one of them is driving the significant explanatory power of patriotism

on foreign holdings. We regress patriotism individually on each of the economic, political

and social correlates, including a survey year dummy variable. Next, we include patrio-

tism and variables to control for the three other possible causes of the equity home bias

in the model to check if the correlate is a driving force behind patriotism’s significant

explanatory power of foreign equity holdings. These results are shown in Table V. Of the

variables listed above, only Charity has explanatory power for foreign equity holdings,

and it does not negate the effect of the patriotism variable.

We conclude from the correlate analysis that patriotism seems to capture a number

of fundamental characteristics of a country’s residents. More religious people are more

patriotic and invest less abroad. We do not draw inference as to what the primal cause

might be. Instead, we show that patriotism is a bundle of properties which may be

influencing portfolio positions.

18

B. Endogeneity

We perform two further robustness checks to determine whether our significant patrio-

tism results are proxying for some omitted variable. First, we test whether patriotism

is endogenous to a country’s equity market performance. We construct the one, three

and ten-year lagged excess market returns for each country in our sample and find that

they do not explain the proportion of foreign equity holdings, either by themselves or

as an offset to patriotism. The lagged returns also do not explain the patriotism score.

Lagged market returns may be a noisy measure of how nationals perceive their home

market’s performance. For this reason, we use the residuals from this regression and find

that the patriotism cross section that is unexplained by lagged returns is still significant

in our analysis.

In that rural populations are insulated more from the influences from the rest of the

world, choose to instrument patriotism with the percentage of the country’s population

that lives in rural areas. The number of people in rural setting will should not be corre-

lated with any omitted variable that is endogenous to patriotism and foreign holdings.

As a first quick test of the appropriateness of our instrument, the correlation between

rural population and the residuals of the full model of foreign holdings on patriotism

and the three standard home bias explanations is not significant at 0.14. In the first

stage of a 2SLS procedure, our instrument significantly covaries with patriotism with an

R-Square of 0.12. Although this R-Square is rather low, the instrumented patriotism is

significant at the 1% level in explaining the Home Bias. The results are presented in

columns 2 and 10 of Table II. In a model of foreign holdings solely on patriotism and

the survey dummy, a Hausman test of the equivalence of the instrumented and the OLS

patriotism coefficients cannot fails to reject. In the full model of foreign holdings on

patriotism, transaction barriers, information and risk, the Hausman test rejects equiva-

lence of the instrumented patriotism coefficient and the OLS coefficient. For this reason,

we calibrate our economic significance results to the use of the instrument.

19

With the OLS patriotism, a one standard deviation change in patriotism would

be associated with a 4% change in foreign holdings percentage. In the instrumented

model, the same change in patriotism is associated with a 2% change in foreign holdings.

Although the economic significance is lowered, a 2% change in foreign holdings relative

to the total equity position is a large impact. For the U.S. and Canada, a shift of

patriotism down to the neutral patriotism score of 2 would explain 9% and 7% of the

home bias. The OLS estimate of the patriotism coefficient explains 21% of the U.S. home

bias and 17% of Canada’s home bias. Finally, we note that inclusion of the instrumented

patriotism in the full model of the standard explanations for the home bias increases

the variation explained of foreign holdings by 11%. This is almost identical to the 12%

increase in R-Squared seen when using the OLS patriotism. The instrumental analysis

concludes that the association of patriotism with foreign equity holdings is very robust

to endogeneity controls.

The second robustness test we undertake is to search for an instrument of patriotism

that is not correlated with economic activity.

C. Alternative Variables

We consider whether alternative measures for transaction barriers, information, and

risk affect the home bias and our patriotism variable. As a further robustness check, we

control for the importance of banks, the extent of development and GDP per capita.

First we consider whether other measures of the existing explanations for the home

bias also explain the effect of patriotism. As alternative control for transactions barriers,

we use a measure of financial restrictions from the EIU Database. Like the IMF variable,

it is positively and significantly related to the extent of equity holdings, but the effect

of patriotism remains.

20

Next, we consider some alternative measures of information available to a country’s

investors. Investors may be more informed if they are ‘close’ to a firm. For example,

it may be more difficult for Japanese investors to learn about foreign investment op-

portunities than for German investors, because Germany is physically close to several

other large capital markets. Hypothesizing that information is negatively affected by

distance, we use three variables to test for the effect of distance. The first is number of

airline departures normalized by population. Air travel is the leading means to travel

abroad, and frequent travel brings people effectively closer to foreign countries where

they can become informed about foreign stocks. Our measure also includes domestic

flights, but the normalization by population (and thus country) size is an attempt to

control for this factor. Airline departures per person are significantly positively related

to foreign investment, suggesting that individuals who travel more often by air invest

more abroad. A one-standard deviation change in airline departures may change foreign

equity holdings by 4.7 percentage points, which is an economic significance similar to

that of television news or transactions barriers.

We also consider two physical distance measures.19 We define proximity over a

domain of all countries B with listed market capitalization as follows:

ProxA = Average

[(MaxDist-DistAB)

MktcapB

Mktcap−A

](1)

Where MaxDist is the maximum distance in between two countries in our sample (we

want to construct a proximity, not a distance variable), DistAB is the distance between

countries A and B, MktcapB is the market capitalization of country B, and Mktcap−A

is the sum of the market capitalizations of all countries excluding A. Table V shows

that this proximity variable is of the right sign - countries that are ‘closer’ using this

variable have higher foreign investment measures - but is not significant. We also employ

a natural measure of distance between a country and the average of all other countries,

19Data for this ‘gravity’ measure is from http://www.macalester.edu/research/economics

21

and it is not significant. We hypothesize that distance may only be important when

comparing local firms to other domestic firms. Since our study is not refined to the level

of Coval and Moskowitz (2001), who have data on individual firms, we are not able to

pick up this distance effect.

We test several financial risk measures for robustness. The first is from Campbell

Harvey’s (1995) Country Risk analysis tables. The study contains several country risk

variables: Credit, Economic, Financial, and Political, but they are pairwise highly corre-

lated (correlation coefficients above .9), so we use only the financial variable. Our second

variable is the Sharpe ratio of the country’s returns, minus the Sharpe ratio of the world

portfolio translated into local currency, to capture exchange rate movements. Sharpe

ratios are constructed with daily returns from the previous year from Datastream and

the one-year LIBOR rate on the last day of the year. If this measure is high, investors

are less likely to gain less from diversifying abroad. Our third variable is the difference

between the variance of stock returns on the local exchange relative to the covariance

of the local exchange with the world market. This is also a measure of diversification

benefits according to the following argument. If markets are segmented, the difference

between the local exchange variance and the covariance between the local and world

markets will be high, and there will be gains from diversification. If this difference is

low, the local market behaves much like the world market, and systematic risk (and the

benefit from diversification) is low.

According to Table VI, both the own country financial risk index, and the measure

of diversification benefits are significant in explaining foreign equity investment. None

of these affects the patriotism variable, and the significance of financial risk disappears

when patriotism is added to the model.

Other variables may be important in explaining the home bias. In this section we

test these variables Following Demirguc-Kunt and Levine (1999) and Zingales (1998),

we include an indicator of whether the economy is bank (relationship) based or market

22

based. Our purpose is to capture investor portfolio choices and not portfolio allocations

by banks. There are competing hypotheses as to the sign of the bank variable. If bankers’

investment choices are less affected by behavioral biases, then the bank coefficient should

be positive and the patriotism coefficient should increase its negativity. Conversely, if

relationship-based systems imply a connection between debt and equity markets, then

the bank variable should be negative. Next, we include an indicator for developing

countries from Demirguc-Kunt and Levine (1999). The holders of foreign equity may

not be representative of domestic investors in developing countries because the state

and large institutions may play a larger role in developing country equity markets. The

developing variable could also capture differences in education, risk, or other factors.

Table ? shows that development is not significant, possibly because of multiple effects

and the low power of an indicator. Finally, we control for GDP per capita. In higher

income countries, a larger proportion of the population invests abroad. We include the

GDP per capita to control for any effects that reflect income in the selection of who

makes the investment decision.

D. Investor Protection

As a final set of robustness checks, we consider the corporate governance environment

of the investing country. Motivation for this section stems from Dahlquist, Pinkowitz,

Stulz and Williamson (2001) (DPSW). DPSW consider the environment of the receiving

country of U.S. outward investment. In particular, they focus on the amount of closely

held shares in a country and the investor protection ratings. The amount of closely

held shares captures the role of the large shareholders in the country in controlling the

market portfolio. Their hypothesis is that closely held percentage measure provides an

indication of the amount of a market available for outside investment. DPSW find that

indeed the closely held measure is consistently positively significant in explaining the

23

U.S. outward investment to that country. Additionally expropriation risk explains a

portion of the variation in investment positions.

In our study, we are focused on the cross-section of investors’ countries rather than

the cross-section of host countries for investment. In DPSW, the governance affects the

amount of inflows of investment. In our study, the overall outflows may be affected by

the governance at home. We construct an average measure of closely held shares for

each country by using the average closely held percentage for a country for all firms in

Worldscope. Then we take the difference between the closely held measure for a country

and the rest of the world average. Table VII presents the result that the closely held

percentage neither increases nor decreases the foreign holdings. Closely held may have

two offsetting effects. On the one hand, the relative percentage of closely held shares may

reflect poorer governance, thus encouraging more foreign investment. Conversely, the

closely measure is a reflection of the investor group for a country. Thus, a higher closely

held percentage may reflect more inward-focused investment if the largest shareholders

are extracting private benefits of control.

To isolate if these governance effects are at work, we follow DPSW and include first

investor protection and then expropriation risk from EIU. Table VII shows that a coun-

try with better investor protection scores and less expropriation risk invest more abroad.

This is inconsistent with the concept that investors flee their own poor governance coun-

tries and is consistent with the hypothesis that a country’s overall investment position

is impacted by inward biases resulting from holding private benefits of control.

V. Conclusion

We test the relation between patriotism and the equity home bias, and find that investors

in more patriotic countries hold smaller foreign equity positions. Similarly, investors in

more patriotic U.S. regions hold less foreign equities. Changes in patriotic behavior

24

are negatively related to changes in foreign equity holdings. This result is robust to

controls for transactions barriers, risk and information, and economic, political and

social correlates of patriotism do not negate the significance of patriotism. We find

strong support for the transaction barriers explanation for the home bias in addition to

patriotism. In our sample, patriotism explains 9-21% of the US home bias and 7-17%

of the Canadian home bias. Additionally, inclusion of patriotism accounts for 12% in

variation of foreign holdings, and a one standard deviation change in patriotism decreases

foreign holdings 2-4%.

Our results are robust to tests of endogeneity. We find that neither instrumenting

patriotism with the percentage of rural population nor including past country index

returns negates the statistical or economic significance of our patriotism result. We also

test for the robustness of the patriotism variable against other measures of transactions

barriers, risk, and information. Last, we consider the role of corporate governance.

Higher investor protection and lower expropriation risk are increasing with foreign equity

holdings. This result is consistent with the hypothesis that domestic investors in poor

governance countries are able to take advantage of private benefits of control. None

of the robustness tests of endogeneity, alternative measures and corporate governance

negates the effect of patriotism on the home bias.

Three implications can be drawn from our study. The first is that irrational behavior

appears to have a large part in explaining the phenomenon that manifests itself in the

home team bias, the 401(k) investment allocations, and the equity home bias. The second

is that non-mean variance optimizing behavior may be a large determinant of investment

decisions. The third implication of this study is that policies aimed at reducing the

home bias may be less successful in countries where investors prefer not to invest abroad

because they are patriotic. Investor education may have an important role in reducing

the home bias. Patriotism results in a winner’s curse in the sense that the person valuing

a stock most highly will ultimately be the highest bidder in any auction. The same theory

25

applies to markets as a whole. The citizens of a country will likely be the highest bidder

for their own country’s assets, thus possibly driving up the price (and capitalization) of

their own market. In a more general equilibrium setting, people invest disproportionately

at home, but a portion of this over-investment is offset by the home biased choices of

other countries. This may push prices upward in more patriotic countries, and downward

in less patriotic countries. Price distortion, however, does not necessarily point to a ”free

lunch” (Barberis, Nicholas and Richard Thaler, (2002). The holding of domestic equities

may enter directly into the utility function. Thus, if one were to hold the mean-variance

portfolio in lieu of the home bias portfolio, one’s utility may be lower. Also, prices

may still be unaffected if there exists a group of deep pocketed arbitrageurs who are

not affected by patriotism and understand the market capitalization biases caused by

countries’ home biases. They can take short (long) positions in a country if domestic

home bias dominates (is subsumed by) the bias of foreign investors choosing not to

invest in that country. This general equilibrium framework leaves avenues for further

exploration of how home bias in general influences the cross section of returns across

countries.

The effect of patriotism may also explain the home bias in consumer products. Lewis

(1999) finds that the equity home bias and the home bias in consumption are linked.

Concurrently, Bennett and Young’s (1999) theoretical model suggests that optimal port-

folios should be biased towards equities in commodities that attract a large share in its

consumption expenditure.20 A future avenue of research will explore whether the ef-

fect of patriotism on the equity home bias comes via consumption choices, and whether

patriotism has the potential to affect prices.

20This is controversial: Uppal’s (1993) theoretical model suggests that it is unlikely.

26

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Appendix A: World Values Survey

The survey is conducted and held by the Inter University Consortium for Political andSocial Research at the University of Michigan. The surveys are designed to enable across-national comparison of values and norms on many topics. Adults 18 and over wereinterviewed face-to-face in 53 countries.

We choose only individuals in the upper half of the income distribution of theircountry. The number of remaining respondents in our sample ranges between 96 and2562 per country. The raw scores are originally 1 for high patriotism and 4 for lowpatriotism, but we subtract them from 5 in order for higher scores to denote higherpatriotism. Other survey variables are subtracted from 5 as well to ease interpretation.

Variable Question Scale

Patriotism “How proud are you to be [insert nationality]?” 1: Very proud

2: Quite proud

3: Not very proud

4: Not at all proud

Religion “Please say, for each of the following, how

important it is in your life. […]Would you say

Religion is…”

4: Very important,

3: Rather important,

2: Not very important

1: Not important at all.

Trust in Government “I am going to name a number of organizations.

For each one, could you tell me how

much confidence you have in them: is it a great

deal of confidence, quite a lot of

confidence, not very much confidence or none at

all? […] The government in [capital city]”

4: A great deal,

3: Quite a lot,

2: Not very much,

1: None at all.

Charity “Now I am going to read off a list of voluntary

organizations; for each one, could you tell

me whether you are an active member, an inactive

member or not a member of that type

of organization? [….] Charitable organization.”

3: Active member,

2: Inactive member,

1: Not a member.

Discuss politics “When you get together with your friends, would

you say you discuss

political matters frequently, occasionally or

never?”

3: Frequently

2: Occasionally

1: Never

Income “Here is a scale of incomes. We would like to

know in what group your household is, counting

all wages, salaries, pensions and other incomes

that come in. Just give the letter of the group your

household falls into, before taxes and other

deductions.”

Income categories coded by

decile for each society, with

1=lowest decile, 10=highest

decile.

Fight “Of course, we all hope that there will not be

another war, but if it were to come to

that, would you be willing to fight for your

country?”

1: No

2: Yes

30

Appendix B: Data Sources

Variable Notation Definition and Source

Flights per 1000

PeopleAIR

World Bank World Development Indicators Database. Count of number of

air departures per person.

Bank vs. Market BANKDemirguc-Kunt and Levine (1999). Rankings are an average of ratios and

range in our sample from negative 2 (market based) to 1 (bank based).

Correlation with

the World CORRWORLD Datastream. Calculated using one lagged year of daily data.

Corruption CORRUPT

University of Goettingen and Transparency International: Internet Center

for Corruption Research. Ranking range from 1 (not corrupt) to 10 (very

corrupt).

Diversification

Risk Reduction DIV_BEN

Datastream. Calculated as variance of country index minus covariance of

the country index with the world market index.

Ethnoliguistic

Fractionalization ETHNOLING

Easterly and Kraay (1999). Measure of linguistic and ethnic group

dispersion ranging from 0 (not very diverse) to 100 (very diverse).

Financial Risk FINRISK Harvey: http://www.duke.edu/~charvey/ Index of financial sector risk

ranging from 0 (low risk) to 100 (high risk). For 1995 only.

Foreign Equity

Holdings FEH

IFS Database. Foreign equity holdings divided by total equity held by

country residents, defined as country market capitalization plus residents’

foreign equity holdings minus foreigners’ equity holdings in the domestic

market.

Foreign Equity

Holdings – U.S. FEH-US

Survey of Consumer Finance (1997). Foreign equity holdings for 9 U.S.

Census regions divided by average region income.

Imports IMPORTS U.N. Comtrade Database. Imports divided by GDP.

Natural Distance NDISTANCE Great Circle. Average distance from a country to 141 other countries.

Newspaper

Circulation NEWSPAPER

World Bank World Development Indicators Database. Circulation of daily

newspapers per 1000 people.

Market Weighted

Proximity PROXIMITY

Great Circle (distance) and Euromonitor (market capitalization). Variable

creating by averaging the difference between the furthest country distance

and all other countries, each weighted by market capitalization.

Capital Account

Liberalization RESTRICTIONS

IMF Capital Account Restrictions from the Exchange Arrangements and

Exchange Restrictions Annual Reports.

Percentage of

Rural Residents RURAL

World Development Indicators. Percentage of population that live in rural

areas.

Tariff and Non-

Tariff Barriers T_NTB

EIU Database. Barrier index ranging from 1 (few barriers) to 5 (many

barriers).

Televisions TV EIU Database. Televisions per capita.

Violent Crime CRIME World Competitiveness Yearbook (1995). Murders, violent crimes and

robberies per 100,000 people in 1993.

31

2.50 3.00 3.50

Patriotism score

0.00

0.10

0.20

0.30

Fo

reig

n e

qu

ity

inve

stm

ent

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

o

oo

o

o

o

oo

France_1

UK_1

Germany_1

Italy_1

NL_1

Denmark_1

Belgium_1

Spain_1

USA_1

Canada_1

S. Africa_1

Sweden_1

Finland_1

Germany_2

Spain_2

USA_2

Japan_2

S. Africa_2

Australia_2

Sweden_2

Argentina_2

Finland_2

Poland_2

Switz_2

Chile_2

Slovenia_2

Turkey_2

Lithuania_2

Latvia_2

Russia_2

Peru_2

Venezuela_2

Moldova_2

Figure 1. Negative Relation Between Foreign Equity Holdings and Patriotism.The dashed line is the fitted regression line. Countries are shown with labels representingsurvey 1 (1992-1993) or survey 2 (1995-1997).

32

-0.10 0.00 0.10 0.20

Change in Patriotism

0.000

0.025

0.050

0.075

0.100

Ch

ang

e in

Fo

reig

n E

qu

ity

Ho

ldin

gs

oo

o

o

o

o

o

Finland

Germany

South Africa

Spain

Sweden

USA

Figure 2. Negative Relation Between the Change in Foreign Equity Holdings andthe Change in Patriotism. The changes are measured from the 1990-1992 survey to the1995-1997 survey.

33

Midwest: East North Central

Northeast: Middle Atlantic

Northeast: New England

West: Pacific Division

Midwest: North Central

South: South Atlantic

Southeast: South Central

West: Mountain Division

Southwest: South Central

3.70 3.75 3.80 3.85

Patriotism score

0.02

0.04

0.06

0.08

Fo

reig

n E

qu

ity

Ho

ldin

gs

Α

Α

ΑΑ

Α

Α

Α

Α

Α

Figure 3. Negative Relation Between U.S. Regional Foreign Equity Holdings andRegional Patriotism Score The 9-level Census division codes are as follows:

1. Northeast: New England Division (CT, ME, MA, NH, RI, VT)2. Northeast: Middle Atlantic Division (NY, NJ, PA)3. South: South Atlantic Division: (DE, DC, FL, GA, MD, NC, SC, VA, WV)4. South: East South Central Division: (AL, KY, MS, TN)5. South: West South Central Division: (AR, LA, OK TX)6. Midwest: East North Central Division (IL, IN, MI OH WI)7. Midwest: West North Central Division (IA, KS, MN, MO,NE, ND, SD)8. West: Mountain Division (AZ, CO, ID, MT, NV, UT, WY, NM)9. West: Pacific Division (AK, CA, HI, OR, WA)

34

Patriotism High Income

Score Observations

Germany 2.70 441

Netherlands 2.87 394

Belgium 2.95 699

France 3.06 287

Italy 3.10 441

Sweden 3.17 401

Spain 3.18 994

Finland 3.19 481

Denmark 3.23 440

Canada 3.51 895

Slovenia 3.51 186

South Africa 3.52 1096

USA 3.72 524

Average 3.21 560

Patriotism High Income

Score Observations

Germany 2.53 527

Latvia 2.77 457

Lithuania 2.80 646

Japan 2.82 349

Russia 2.89 844

Moldova 2.97 168

Switzerland 2.98 708

Finland 3.39 284

Argentina 3.33 316

Sweden 3.33 465

Spain 3.41 474

Chile 3.46 491

Turkey 3.46 488

Poland 3.64 25

Australia 3.69 803

Peru 3.79 134

USA 3.79 858

South Africa 3.80 2562

Venezuela 3.89 96

Average 3.30 563

Country

Second Wave: 1995-1997

Country

Table I

Patriotism Scores Across Countries

The Patriotism Score refers to the average answer for high income residents of a

country to the question: "Are you proud to be [insert nationality]?".

First Wave: 1990-1992

35

OL

SIV

-ru

ral

OL

SO

LS

OL

SO

LS

OL

SO

LS

OL

SIV

-ru

ral

12

34

56

78

91

0

Pa

trio

tism

-0.1

09

**

-0.0

48

**

*-0

.08

7*

*-0

.09

1*

-0.1

07

**

-0.1

06

**

-0.0

51

**

(2.2

3)

(2.8

4)

(2.0

6)

(1.8

4)

(2.4

8)

(2.5

8)

(2.4

7)

Res

tric

tio

ns

-0.1

15

**

*-0

.10

5*

**

-0.0

84

**

-0.0

62

**

(3.6

4)

(3.4

8)

(2.7

3)

(1.9

1)

New

spa

per

s0

.21

6*

0.1

61

0.0

13

0.0

43

(1.8

5)

(1.3

8)

(0.1

5)

(0.5

0)

Co

rrW

orl

d0

.27

3*

**

0.2

52

**

*0

.12

40

.07

0

(2.9

7)

(3.0

0)

(1.3

8)

0.0

8

Su

rvey

Du

mY

YY

YY

YY

YY

Y

Ob

s3

33

33

33

33

33

32

82

82

82

8

R²

0.2

20

.29

0.3

70

.45

0.1

90

.27

0.3

70

.50

0.6

30

.62

Ha

usm

an

p-v

alu

e0

.17

0.0

3

Ta

ble

II

Est

ima

tio

ns

Sh

ow

ing

Pa

trio

tism

's S

ign

ific

an

ce i

n E

xp

lain

ing

th

e H

om

e B

ias

Dep

end

ent

Va

ria

ble

: F

ore

ign

Eq

uit

y H

old

ing

s

OL

S a

nd I

V e

stim

ates

are

rep

ort

ed f

or

regre

ssio

ns

of

fore

ign e

quit

y h

old

ings

on t

he

pat

rioti

sm s

core

and t

he

stan

dar

d e

xpla

nat

ions

for

hom

e bia

s. F

ore

ign

hold

ings

is t

he

per

centa

ge

of

a co

untr

y's

tota

l eq

uit

y h

old

ings

that

is

fore

ign, ca

lcula

ted f

rom

IF

S d

ata.

P

atri

oti

sm i

s fr

om

the

Worl

d V

alues

Surv

ey a

nd i

s

an i

ncr

easi

ng i

ndex

fro

m 1

to 4

. R

estr

icti

ons

is a

n I

MF

indic

ator

var

iable

of

Cap

ital

Acc

ount

Res

tric

tions.

N

ewsp

aper

s is

the

amount

of

dai

ly c

ircu

lati

on

per

1,0

00 p

eople

fro

m W

orl

d D

evel

opm

ent

Indic

ators

. C

orr

Worl

d i

s a

calc

ula

ted v

aria

ble

of

the

corr

elat

ion o

f a

countr

y's

mar

ket

index

wit

h t

he

rest

of

the

worl

d;

Corr

Worl

d i

s ca

lcula

ted f

rom

dai

ly r

eturn

s fo

r 1 y

ear

pri

or

to t

he

surv

ey d

ate

wit

h D

atas

trea

m d

ata.

In c

olu

mns

2 a

nd 1

0, P

atri

oti

sm i

s in

stru

men

ted b

y t

he

per

centa

ge

of

rura

l popula

tion. T

he

Hau

sman

p-v

alues

res

ult

fro

m t

he

test

that

the

OL

S e

stim

ator

is

a co

nsi

sten

t an

d e

ffic

ient

esti

mat

or

of

the

true

par

amet

er. T

he

null

hypoth

esis

is

that

the

IV c

oef

fici

ent

on p

atri

oti

sm i

s eq

ual

to t

he

coef

fici

ent

on t

he

inst

rum

ente

d p

atri

oti

sm v

arai

ble

. S

ignif

ican

ce a

t th

e 10\%

, 5\%

and 1

\% l

evel

s ar

e in

dic

ated

by *

, ** a

nd *

** r

espec

tivel

y.

T-s

tati

stic

s ar

e re

port

ed i

n

par

enth

eses

.

36

Var

iab

leE

stim

ated

Coe

ffic

ien

t

Ch

ange

in

For

eign

Eq

uit

y H

old

ings

for

1

Sta

nd

ard

Dev

iati

on

Ch

ange

in

Var

iab

le

Ch

ange

in

R²

wh

en

Var

iab

le A

dd

ed t

o F

ull

Mod

el

Pat

riot

ism

-0.1

16-0

.039

0.12

4

Res

tric

tion

s-0

.086

-0.0

410.

128

New

spap

ers

0.12

20.

020

0.00

8

Cor

rWor

ld0.

194

0.03

90.

037

Tab

le I

II

Eco

nom

ic S

ign

ific

ance

of

Pat

riot

ism

an

d S

tan

dar

d E

xpla

nat

ion

s

Mea

sure

s of

eco

nom

ic s

igni

fica

nce

are

expl

ored

in

colu

mns

tw

o an

d th

ree.

Col

umn

two

repo

rts

the

chan

ge i

n

the

perc

enta

ge o

f eq

uity

hol

ding

s th

at a

re f

orei

gn f

or a

one

sta

ndar

d de

viat

ion

chan

ge i

n th

e ro

w v

aria

ble.

The

fin

al c

olum

n sh

ows

the

chan

ge i

n R

-Squ

ared

tha

t oc

curs

whe

n th

e ro

w v

aria

ble

is a

dded

to

the

full

mod

el

of f

orei

gn e

quit

y ho

ldin

gs o

n th

e su

rvey

yea

r du

mm

y, p

atio

tism

, tra

nsac

tion

res

tric

tion

s, n

ewsp

aper

s pe

r

capi

ta, t

he c

orre

lati

on o

f th

e co

untr

y m

arke

t w

ith

the

wor

ld, a

nd G

DP

per

cap

ita.

The

ful

l m

odel

is

defi

ned

to

be a

ll o

f th

e va

riab

les

exce

pt t

he o

ne t

hat

is a

dded

for

cal

cula

ting

the

cha

nge

in R

-Squ

ared

.

37

Patr

iotis

m

1

GD

P/C

ap-0

.25

**1

Ineq

ualit

y0.

40**

*-0

.25

*1

Cri

me

0.41

***

-0.1

9-0

.03

1

Cor

rupt

ion

0.26

*-0

.83

***

0.51

***

0.05

1

Dis

cuss

-0.3

2**

*-0

.01

-0.3

6**

*-0

.02

-0.1

61

Tru

st G

ov0.

180.

110.

070.

24-0

.20

-0.1

71

Eth

nolin

g0.

43**

*-0

.35

**0.

39**

*0.

630.

33**

0.03

0.23

1

Cha

rity

0.23

*0.

31**

0.25

*0.

41**

-0.1

9-0

.02

-0.1

20.

101

Rel

igio

n0.

67**

*-0

.52

***

0.61

***

0.44

***

0.59

***

-0.3

7**

*0.

180.

56**

*0.

18

Tru

st G

ovE

thno

ling

Tab

le IV

Part

ial C

orre

latio

ns, C

ontr

ollin

g fo

r Su

rvey

Yea

r, o

f Pat

riot

ism

and

Eco

nom

ic, P

oliti

cal a

nd S

ocia

l Var

iabl

esPa

rtial

cor

rela

tions

, con

trolli

ng fo

r sur

vey

year

, are

pre

sent

ed fo

r eco

nom

ic, p

oliti

cal,

and

soci

al c

orre

late

s with

pat

riotis

m.

Econ

omic

cor

rela

tes a

re in

com

e an

d

ineq

ualit

y. G

DP/

Cap

is fr

om th

e W

orld

Dev

elop

men

t Ind

icat

ors.

Ineq

ualit

y is

the

Thei

l Ind

ex fr

om th

e U

nive

rity

of T

exas

at A

ustin

. Po

litic

al c

orre

late

s are

crim

e,

corr

uptio

n, d

iscu

ss p

oliti

cs, a

nd tr

ust o

f gov

ernm

ent.

Crim

e is

vio

lent

crim

es p

er 1

00,0

00 p

eopl

e in

199

3 fr

om th

e W

orld

Com

petit

iven

ess y

earb

ook.

Cor

rupt

ion

is th

e

Tran

pare

ncy

Inte

rnat

iona

l Ind

ex in

crea

sing

in c

orru

ptio

n fo

rm 1

to 1

0. D

iscu

ss re

fers

to th

e W

orld

Val

ues S

urve

y qu

estio

n of

how

ofte

n an

indi

vidu

al d

iscu

sses

polit

ics.

Tru

st o

f gov

ernm

ent i

s the

resp

onse

to th

e w

orld

val

ues s

urve

y of

whe

ther

an

indi

vidu

al tr

usts

the

gove

rnm

ent.

Soc

ial c

orre

late

s are

ent

holin

guis

tic

disp

ersi

on, c

harit

y an

d re

ligio

n. E

thno

lingu

istic

dis

pers

ion

is a

n in

dex

from

Eas

terly

and

Kra

ay (1

999)

. C

harit

y is

the

resp

onse

to th

e W

orld

Val

ues S

urve

y qu

estio

n

of c

harit

able

act

ivity

. R

elig

ion

is th

e re

spon

se to

the

Wor

ld V

alue

s Sur

vey

of h

ow re

ligio

us a

n in

divi

dual

rate

s her

self.

Sig

nific

ance

in th

e pa

rtial

cor

rela

tions

is

deno

ted

by *

, **,

and

***

for t

he 1

0%, 5

% a

nd 1

% le

vels

resp

ectiv

ely.

Patr

iotis

mG

DP/

Cap

Ineq

ualit

yC

rim

eC

hari

tyC

orru

ptio

nD

iscu

ss

38

1 2 3 4 5 6 7 8

Patriotism -0.115 ** -0.092 * -0.122 ** -0.116 ** -0.112 ** -0.134 ** -0.165 *** -0.133 **

(2.67) (1.79) (2.41) (2.75) (2.66) (2.39) (3.62) (2.15)

Restrictions -0.087 ** -0.079 ** -0.083 ** -0.073 ** -0.097 ** -0.088 ** -0.079 ** -0.087 **

(2.77) (2.45) (2.71) (2.19) (2.77) (2.69) (2.71) (2.75)

Newspaper 0.1284 -0.045 -0.083 -0.102 0.001 0.042 0.031 0.060

(0.73) (0.43) (0.90) (0.85) (0.02) (0.38) (0.36) (0.50)

CorrWorld 0.1924 -0.126 -0.050 -0.090 0.103 0.103 0.008 0.127

(1.50) (1.36) (0.47) (0.97) (1.09) (0.99) 0.09 (1.40)

GDP/Cap -2.730

(0.76)

Inequality 0.002

(0.47)

Crime 0.277

(1.05)

Corruption -0.015

(1.42)

Discuss -0.075

(0.78)

Enthnoling 0.483

(0.59)

Charity 0.274 **

(2.39)

Religion 0.033(0.59)

Survey Dum Y Y Y Y Y Y Y Y

Obs 28 27 25 27 28 26 26 28

R2

0.64 0.60 0.67 0.66 0.64 0.62 0.70 0.63

Table V

Regressions Showing the Patriotism Result is Not Driven Solely by Correlates

OLS estimates are reported for regressions of foreign equity holdings on the patriotism score and significant patriotism correlates.

Foreign holdings is the percentage of a country's total equity holdings that is foreign, calculated from IFS data. Patriotism is from the

World Values Survey and is an increasing index from 1 to 4. Restrictions is an IMF indicator variable of Capital Account Restrictions.

Newspapers is the amount of daily circulation per 1,000 people from World Development Indicators. CorrWorld is a calculated variable

of the correlation of a country's market index with the rest of the world; CorrWolrd is calculated from daily returns for 1 year prior to the

survey date with Datastream data. GDP/Cap is GDP (in millions) per capita from World Development Indicators. Crime isviolent

crimes per 100,000 people in 1993 from the World Competitiveness yearbook. Corruption is the Tranparency International Index

increasing in corruption form 1 to 10. Discuss refers to the World Values Survey question of how often an individual discusses politics.

Enthnoling is the enthnoliguistic dispersion from Easterly and Kraay (1999). Charity and Religion are World Values Survey questions

asking whether the individual participates in charitable and religious activity. Significance at the 10\%, 5\% and 1\% levels are

indicated by *, ** and *** respectively. T-statistics are reported in parentheses.

39

1 2 3 4 5 6 7 8

Patriotism -0.148 *** -0.097 * -0.136 *** -0.101 * -0.106 * -0.125 ** -0.108 ** -0.144 **

(2.89) (1.96) (3.05) (1.74) (1.88) (2.61) (2.17) (2.57)Barriers

T_NTB 0.051

(2.04) *Information

TV/Cap 0.206 *

(1.79)

AirDepart 0.005 ***

(2.96)

Proximity 0.168

(0.29)

NDistance 0.001

(0.12)Risk

DivBene -5.770

(1.56)

Sharpe -0.168

(0.17)

FinRisk -0.005 *

(1.75)

Survey Dum Y Y Y Y Y Y Y Y

R2

0.39 0.31 0.40 0.22 0.22 0.38 0.22 0.42

Obs 29 32 33 33 33 28 33 33

Table VI

Robustness Regressions: Patriotism's Significance with Other Measures of Home Bias ExplanationsOLS estimates are reported for regressions of foreign equity holdings on patriotism and alternative measures of transaction

barriers, information and risk. Foreign holdings is the percentage of a country's total equity holdings that is foreign,

calculated from IFS data. Patriotism is from the World Values Survey and is an increasing index from 1 to 4. T_NTB is

an index of tariff and nontariff barriers from the EIU. Televisions per capita is also from EIU. AirDepart is the number of

flight departures per person from World Development Indicators. Proximity is a average market weighted distance to all

other countries. The natural distance measure is from Great Circle. DiveBene is diversification benefits calculated as

varaince of a country index minus the covaraince with the world market index. Sharpe is the country index Sharpe ratio

calculated from Datastream data. Finrisk is Cambel Harvey's index of financial sector risk. Significance at the 10\%, 5\%

and 1\% levels are indicated by *, ** and *** respectively. T-statistics are reported in parentheses.

40

1 2 3 4 5 6

Patriotism -0.228 *** -0.141 ** -0.155 ***

(3.22) (2.74) (2.99)

Closely 0.0899 -1.811

(0.04) (0.97)

InvestProt 0.0393 ** 0.0341 **

(2.22) (2.14)

Expropriate 0.072 0.074 *

(1.61) (1.88)

Survey Dum Y Y Y Y Y Y

Obs 22 22 29 29 29 29

R² 0.06 0.40 0.21 0.39 0.15 0.37

Dependent Variable: Foreign Equity Holdings

Table VII

Patriotism and the Role of Corporate Governance for Foreign Holdings

OLS estimates are reported for regressions of foreign equity holdings on the patriotism score and

corporate governance measures. Foreign holdings is the percentage of a country's total equity holdings

that is foreign, calculated from IFS data. Patriotism is from the World Values Survey and is an

increasing index from 1 to 4. Closely is the average percentage of closely held shares for all

Worldscope country firms minus the average closely held percentage from the rest of the world.

Investor protection and expropriation risk are from EIU; both of these measures are increasing in better

protection.

41