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Sunday, February 26, 2012

The persistence of Home Bias (explained)

Every time I teach international portfolio theory to my students I have to face the inevitable question.

Diversifying one's portfolio --> good.
International diversification --> Much better

If it is so good to diversify abroad... then why don't people do it?
well... This is Home Bias, or the tendency of investors to hold a disproportionate amount of shares from their own home country.
The chart below will serve for illustration (figures as of 2010):

The US stock market represents almost 30% of the world's stock market. (Down from 40% in 2005) A rational American investor should have 30% of her money in American stocks. A French investor should have only 3.55% of his money in French companies and the rest spread through the world. In reality investors hold most of their portfolio in companies in their own countries.
The next chart shows that Germans hold almost 50% of their portfolio in German stocks.  If they were rational, they should hold no more than 3%.

To make matters worse, another 35% is Eurozone + UK

This is not rational. Investors are leaving money on the table. It is a puzzle.

The answers to this puzzle go from
Capital immobility... Investors can not move their money freely across countries... (taxes and other restrictions) to Information immobility... foreigners have better information about their own countries, How can an American investor make sense of the French or Chilean markets. A third explanations refers to Consumption hedging; Mexican investors invest in Mexico because they consume (now and in the future) in Mexican Pesos. Mexican companies provide a natural hedge against currency fluctuations which can be very wide and have profound implications. See my blog on Brazil versus Mexico.

There is a great video by Ken French from Tuck further explaining the topic.

I am an optimistic. A recent article in the Financial Times shows that in 1980 Americans held 2% of their portfolio overseas by 2007 it was 27%. This is a dramatic improvement.

Wednesday, February 22, 2012

Have you checked your Norepinephrine lately?

Cholesterol and glucose levels are things of the past for financial professionals...

According to a recent study by Takahashi et al. (2012) we should check traders for their levels of norepinephrine. It turns out that this chemical is crucial for the way we handle losses.
People with high levels of norepniphrine are "numb" or less sensitive to the pain of losing money. They could make better traders.
Those poor souls with high levels of the chemical suffer from loss aversion. They show more emotions for loses than gains.

Sunday, February 5, 2012

Brazil versus Mexico

Brazil gets all the press. After all, It is the "B" in brics.
Mexico... Well you have the drug cartels and the doings of Carlos Slim.

But something else is going on quietly. Mexican automakers are gaining productivity and market share. To the point that Brazil is scared. So concerned that insiders believe that Dilma Rousseff (Brazil's president) may be close to revert a free trade agreement (only for cars) between the countries and it could even impose a possible tariff to Mexican cars imported into Brazil.
Why the rush? A FT article indicates that last year Brazilian imports of Mexican cars grew 40% to reaching a deficit on USD 1.6 billion.

Yes, Mexico and China are able to export large numbers of cars to Brazil. At the same time Brazilian cars are not enjoying the same bonanza abroad.
The reason for this drop in competitiveness? There is never only 1 reason but the chart below surely explains a lot.

The BRL has appreciated against the dollar while the MXN has depreciated. Things made in Brazil are more (a lot more) expensive than those made in Mexico...

Furthermore... look at the euro... same picture

If you are Ford or VW where would you put your next plant: Brazil or Mexico?