The effect of political stability and confidence in economic policy on cross-border fixed income portfolio allocation

Abstract

This thesis investigates the extent of home bias in bond portfolios in 20 countries, in the time period 2001 to 2016. In additional to traditional drivers of portfolio optimization, we consider the impact of the financial crisis, political stability and economic policy on cross-border fixed income allocation. The thesis is mainly based on data from the Coordinated Portfolio Investment Survey by the International Monetary Fund and Ifo World Economic Survey. In our investigation of home bias, we find a declining trend throughout the period. We find that the strongest drivers of cross-border bond portfolio allocation are rational portfolio optimization factors, the degree of underweight and diversification benefits. These results indicate that investors aim to reallocate their portfolio and close the distance between actual weights and optimal weights following the International Capital Asset Pricing Model to achieve a diversified portfolio. We find a significant negative relationship between cross-border bond portfolio holdings and political stability, and a significant positive relationship between cross-border bond portfolio holdings and confidence in economic policy.