DP3228 Traders, Courts and the Home Bias Puzzle

Author(s): Alessandro Antonio Turrini , Tanguy van Ypersele

Publication Date: February 2002

Keyword(s): cros-border trade , legal costs , matching

JEL(s): F12

Programme Areas: International Trade and Regional Economics , Public Policy

Link to this Page: www.cepr.org/pubs/dps/DP3228.asp

Recent evidence shows that the ‘home bias puzzle’ in international trade may be associated with the mere presence of national borders (McCallum (1995)). In this Paper we provide a theoretical framework to explain why borders may matter so much for trade. Our argument is that even between perfectly integrated and similar countries the legal system differs, so that legal costs are higher when business is done abroad. Using a matching model of trade, we show that the home bias is associated with both less searching foreign sellers in the home market and a lower probability of cross-border matches being accepted. In industries characterized by high turnover legal costs may reduce trade because reducing the mass of searching foreign sellers and increasing at the same time that of searching domestic sellers.