George Andrew Karolyi, David Ng, Eswar Prasad — .The coming wave: Where emerging market investors will put their money

Few economists understate the importance of emerging market economies in terms of world GDP and global growth prospects. This column asks where the future of emerging markets’ investments lie. Where investors have focused in the past and institutional path dependency are important determinants of emerging markets’ allocation of international investment portfolios. This has implications for the geographical distribution of emerging markets’ portfolio investments, a force to reckon with in international financial markets.…

To guide our empirical analysis, we then turn to the concept of information immobility proposed by van Nieuwerburgh and Veldkamp (2009, 2010). Rather than relying on information asymmetries, which should in principle decline over time, their theoretical model recognises that investors face a choice in deciding about which assets to acquire information when there are multiple risky assets in the investment opportunity set. For instance, investors have a comparative advantage in learning about their domestic assets. Even as information about foreign markets becomes easier to obtain, the initial information endowment leads investors to exert more effort in acquiring additional information about domestic assets, magnifying their comparative advantage. Similarly, investors would prefer to invest in foreign countries where they had an initial information endowment.

We propose empirical proxies on a country level and on an institutional investor level to detect possible emerging market investors’ information endowments for a particular destination country for their outward investments. On a country level, the proxies are historical foreign direct investment and trade flows between the home and destination country for outward portfolio investments. Such historical foreign and direct investment and trade flows typically result in business contacts and investment relationships that could serve as a source of the initial information endowment.

Transaction costs involved in gathering, processing, evaluating, and acting on information favors existing patterns as "endowments." 

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The coming wave: Where emerging market investors will put their money
George Andrew Karoly, Professor of Finance, Samuel Curtis Johnson Graduate School of Management, Cornell University, David Ng, Professor of Finance, Cornell University, and Eswar Prasad, Tolani Senior Professor of Trade Policy at Cornell University, Senior Fellow of the Brookings Institution and Research Associate, NBER
ht Mark Thoma at Economist's View