Generalizing Cooper-Kaplanis (1994), we estimate implied costs that reconcile international portfolios with InCAPM predictions. Costs depend on home- and host-country characteristics and on interactions; we estimate risk tolerance rather than pre-specifying it; and we control for currency risk, inflation hedging, fixed-interest investments, round-tripping and omitted countries. Estimates for developed markets are lower than reported before, but those for new markets are quite high: 2001-2004 inward shadow costs range from 0.01 %p.a. (US) to 37 (Indonesia). We find that equity home bias is related to a mixture of risks and frictions, such as information asymmetries, institutional factors and explicit costs.

The literature on international equity holdings distinguishes between home bias (overweighting of home stocks) and foreign bias (relative underweighting for more “distant” countries). The two biases can be integrated into one distance-based model. We define pure home bias as the excess of home bias relative to this model, and find pure home bias only in emerging markets. Countries with high tax rates and low credit standing have higher pure home bias, and more development comes with lower distance aversion. Methodologically, the choice of portfolio bias measure matters. We find the best measure to be a covariance-based measure relative to the world average.

A sovereign creditrating is a function of hard and soft information that should reflect the creditworthiness and the probability of default of a country. We propose an alternative characterisation for the subjective component of a sovereign credit rating – the parts related to the ratee’s lobbying effort or its familiarity from a United States point of view – and apply it to S&P, Moody’s and Fitch ratings, using both traditional ordered-logit panel models and machine learning techniques. This subjective component turns out to be large, especially for the low-rated countries. Countries that are rated as investment grade tend to be positively influenced by it, and vice versa. Subjective judgment in credit ratings does have predictive value: it helps in identifying chances of sovereign defaults in the short-term. Still, the impact of subjectivity in sovereign ratings on borrowing costs is very limited on average.