Home bias, risk differential, and cultural spatial spillover effects

• The spatial spillover effects of return and risk associated with common culture on home bias.
• A spatial panel model to utilize unique weight matrices to capture the spillover effects.
• The risk differential model of home bias in international portfolio flows.
• Colonial relationship, contiguity, cultural similarity, economic freedom, economic distance.
• Geometric distance, language, power distance.

This paper aims to uncover the role of heterogeneity and spillover effects of return and risk on home bias associated with common background characteristics of trading countries. We adopt a spatial panel model to utilize uniquely created weight matrices and capture the spatial spillover effects of the common background characteristics. A modified definition of home bias is used to explore the role of market risks associated with the common characteristics of cross-border portfolio flows in an international portfolio balance model. Using annual panel data of 17 countries spread over three different regions (i.e., Asia, Europe, and others) for the 2002–2012 period, evidence strongly supports our hypothesis that the effects of the return and risk differentials of trading countries on home bias depend on the correlation of each of the common characteristics with return and risk.