American Political Science Review Vol.104.No.3 about regulations and procedures,or familiarity with asset pricing model.The standard international cap- language and customs that can decrease the transaction ital asset pricing model(ICAPM)predicts that in the costs associated with cross-border investment. absence of information asymmetries and transactions We test our argument using a dyadic data set com- costs.investors should hold domestic assets in their posed of both portfolio and FDI from as many as 56 portfolio in proportion to their country's share of source countries into up to 154 destination countries global capital market capitalization.2 However con- for the year 2002.The use of portfolio and FDI al- vincing in theory,overwhelming empirical evidence lows us to be more general about the implications demonstrates that investor behavior deviates consid- of our findings as these investment types are funda- erably from this benchmark model.The empirical find- mentally different.While portfolio investors purchase ing that investors forgo substantial gains by investing stocks and bonds in open markets,foreign direct in- at home rather than abroad has spawned a huge lit- vestors purchase fixed shares in plants or in machinery. erature trying to explain this "home bias,"a systemic More important,within a country,portfolio investment preference for assets that are available in their home opportunities are constrained by the shares issued by market (e.g.,Lewis 1999). corporate or government entities,whereas FDI possi- What does the literature say about the lack of inter- bilities are unbounded in both their content and their national diversification?In early work on the "home ownership stake. bias,"French and Poterba(1991)argue that investors Giving pride of place to migrant networks in ex- purchase domestic assets as a consequence of what they plaining the cross-national allocation of capital al- call"familiarity"effects.Tesar and Werner (1995)are a lows us to speak to a number of seemingly disparate bit more specific when they attribute the taste for home literatures.Broadly speaking,the emphasis on dias- rather than foreign assets to factors such as"language pora networks as a conduit for capital flows is a nat- [and]institutional and regulator difference"(p.479).In ural extension of Keohane and Nye's (1974)work addition to taste.Coval and Moskowitz(2001)attribute on transnational-or nongovernmental-relations be- the home bias to asymmetries of information and argue tween states.Although other scholarship from inter- that investors have better information about assets sold national relations fits within the category of transna- in geographically closer markets.3 tionalism,it tends to focus on nongovernmental or In a cross-national context,it is difficult to separate intergovernmental organizations (e.g.,Keck and familiarity and cultural preferences for home products Sikkink 1998:Slaughter 2004).Emphasizing the role from informational asymmetries.To minimize prob- of migrant networks in cross-national investment pro- lems of model misspecification associated with omitted vides another mechanism-this one noninstitutional- variable bias,empirical studies of cross-border invest- by which we can understand the growing degree of ment tend to exploit gravity-type models of interna- interdependence that exists within the international tional transactions.Drawn from gravity models of in- system.From the perspective of international relations ternational trade,which in turn are (loosely)derived theory,our emphasis on migrant communities influ- from Newton's Law of Gravity,these models hold that encing their homelands allows us to speak to the grow- bilateral transactions are a positive function of the size ing interest in diaspora politics (e.g.,Shain and Barth of the two economies(their mass)and a negative func- 2003;Sheffer 2003).By privileging human networks,we tion of the distance between them.In dealing with the highlight the importance of mechanisms other than for- empirical fact that investors exhibit a home bias,schol- mal institutions for channeling economic activity(e.g., ars"augment"these gravity models with a variety of Greif1989.1993). variables.Eichengreen and Luengnaruemitchai (2006), Our arguments and evidence are developed in this Lane and Milesi-Ferretti(2004),and Rose and Spiegel article.The first section contains our theoretical dis- (2008),for example,include variables that measure cussion and embeds our argument within the context whether the country pair shares a common language,a of international asset pricing theory.The next section common border,or a common colonial heritage.These lays out the empirical model and details the statisti- cal methodology we use.In the following section,we present our central statistical results and document the We reference much of this literature in what follows.For overviews, robustness of those findings.The last section concludes see Lane and Milesi-Ferretti (2004),Lewis (1999).Portes and Rey and offers suggestions for future research. (2005).and Sarkissian and Schill (2004). 2 See Lane (2005)and Lane and Milesi-Ferretti (2004)for studies of bilateral investment that are explicitly derived from the ICAPM Elton et al.(2003)provide a textbook exposition of the capital asset pricing model. Grinblatt and Keloharju(2001),Huberman(2001),and Portes and DIASPORA NETWORKS AND INVESTMENT Rey (2005)also find that investors tend to purchase assets sold in [more proximate markets.These articles attribute this behavior to Modeling Bilateral Investment the idea that investors have better(less asymmetric)information as distance between markets decreases.Coval and Moskowitz (1999, Our argument is that migrant networks are a mech- 2001)attempt to distinguish between familiarity and information anism helping direct portfolio and FDI from the mi- asymmetries.Their 1999 study documents that investors prefer to grant's host country to their country of origin.We invest in the "familiar,"whereas their 2001 article provides some evidence in favor of the information asymmetry hypothesis.It is situate our argument within the international finance worth noting that their earlier article does not distinguish between literature and ground it in the international capital the two explanations. 585American Political Science Review Vol. 104, No. 3 about regulations and procedures, or familiarity with language and customs that can decrease the transaction costs associated with cross-border investment. We test our argument using a dyadic data set com￾posed of both portfolio and FDI from as many as 56 source countries into up to 154 destination countries for the year 2002. The use of portfolio and FDI al￾lows us to be more general about the implications of our findings as these investment types are funda￾mentally different. While portfolio investors purchase stocks and bonds in open markets, foreign direct in￾vestors purchase fixed shares in plants or in machinery. More important, within a country, portfolio investment opportunities are constrained by the shares issued by corporate or government entities, whereas FDI possi￾bilities are unbounded in both their content and their ownership stake. Giving pride of place to migrant networks in ex￾plaining the cross-national allocation of capital al￾lows us to speak to a number of seemingly disparate literatures. Broadly speaking, the emphasis on dias￾pora networks as a conduit for capital flows is a nat￾ural extension of Keohane and Nye’s (1974) work on transnational—or nongovernmental—relations be￾tween states. Although other scholarship from inter￾national relations fits within the category of transna￾tionalism, it tends to focus on nongovernmental or intergovernmental organizations (e.g., Keck and Sikkink 1998; Slaughter 2004). Emphasizing the role of migrant networks in cross-national investment pro￾vides another mechanism—this one noninstitutional— by which we can understand the growing degree of interdependence that exists within the international system. From the perspective of international relations theory, our emphasis on migrant communities influ￾encing their homelands allows us to speak to the grow￾ing interest in diaspora politics (e.g., Shain and Barth 2003; Sheffer 2003). By privileging human networks, we highlight the importance of mechanisms other than for￾mal institutions for channeling economic activity (e.g., Greif 1989, 1993). Our arguments and evidence are developed in this article. The first section contains our theoretical dis￾cussion and embeds our argument within the context of international asset pricing theory. The next section lays out the empirical model and details the statisti￾cal methodology we use. In the following section, we present our central statistical results and document the robustness of those findings. The last section concludes and offers suggestions for future research. DIASPORA NETWORKS AND INVESTMENT Modeling Bilateral Investment Our argument is that migrant networks are a mech￾anism helping direct portfolio and FDI from the mi￾grant’s host country to their country of origin. We situate our argument within the international finance literature and ground it in the international capital asset pricing model.1 The standard international cap￾ital asset pricing model (ICAPM) predicts that in the absence of information asymmetries and transactions costs, investors should hold domestic assets in their portfolio in proportion to their country’s share of global capital market capitalization.2 However con￾vincing in theory, overwhelming empirical evidence demonstrates that investor behavior deviates consid￾erably from this benchmark model. The empirical find￾ing that investors forgo substantial gains by investing at home rather than abroad has spawned a huge lit￾erature trying to explain this “home bias,” a systemic preference for assets that are available in their home market (e.g., Lewis 1999). What does the literature say about the lack of inter￾national diversification? In early work on the “home bias,” French and Poterba (1991) argue that investors purchase domestic assets as a consequence of what they call “familiarity” effects. Tesar and Werner (1995) are a bit more specific when they attribute the taste for home rather than foreign assets to factors such as “language [and] institutional and regulator difference” (p. 479). In addition to taste, Coval and Moskowitz (2001) attribute the home bias to asymmetries of information and argue that investors have better information about assets sold in geographically closer markets.3 In a cross-national context, it is difficult to separate familiarity and cultural preferences for home products from informational asymmetries. To minimize prob￾lems of model misspecification associated with omitted variable bias, empirical studies of cross-border invest￾ment tend to exploit gravity-type models of interna￾tional transactions. Drawn from gravity models of in￾ternational trade, which in turn are (loosely) derived from Newton’s Law of Gravity, these models hold that bilateral transactions are a positive function of the size of the two economies (their mass) and a negative func￾tion of the distance between them. In dealing with the empirical fact that investors exhibit a home bias, schol￾ars “augment” these gravity models with a variety of variables. Eichengreen and Luengnaruemitchai (2006), Lane and Milesi-Ferretti (2004), and Rose and Spiegel (2008), for example, include variables that measure whether the country pair shares a common language, a common border, or a common colonial heritage. These 1 We reference much of this literature in what follows. For overviews, see Lane and Milesi-Ferretti (2004), Lewis (1999), Portes and Rey (2005), and Sarkissian and Schill (2004). 2 See Lane (2005) and Lane and Milesi-Ferretti (2004) for studies of bilateral investment that are explicitly derived from the ICAPM. Elton et al. (2003) provide a textbook exposition of the capital asset pricing model. 3 Grinblatt and Keloharju (2001), Huberman (2001), and Portes and Rey (2005) also find that investors tend to purchase assets sold in [more] proximate markets. These articles attribute this behavior to the idea that investors have better (less asymmetric) information as distance between markets decreases. Coval and Moskowitz (1999, 2001) attempt to distinguish between familiarity and information asymmetries. Their 1999 study documents that investors prefer to invest in the “familiar,” whereas their 2001 article provides some evidence in favor of the information asymmetry hypothesis. It is worth noting that their earlier article does not distinguish between the two explanations. 585