The original Rabbinic enactment to light candles on Hanukah required that the candles be lit outside one's home, near the street. However, the Sages granted a dispensation in times of "Sakana," when lighting in public would likely arouse hostility among the gentile neighbors, allowing people living under such conditions to light the candles inside their homes. Thus, during periods when the Jews lived among hostile gentiles, the custom developed to kindle the Hanukah lights inside their homes. Nowadays, however, most Jews live in places where no such danger exists. (This is particularly so in Israel, which is, thank God, a predominantly Jewish country.) Seemingly, then, it is proper nowadays to light the Hanukah candles outside the home, in accordance with the initial enactment.
The Aruch Ha'shulhan (Halachic work by Rabbi Yechiel Michel Epstein, Byelorussia, 1829-1908), however, observed (O.H. 671:24) that many Jews continued the practice of lighting inside their homes even in exclusively Jewish communities or in areas with a peaceful gentile population. He justifies this practice by claiming that it resulted from the harsh winter conditions in many places during the season of Hanukah, which made outdoor lighting impractical, or at least very difficult. For this reason, the Aruch Ha'shulhan suggests, communities continued the practice of lighting indoors even if no danger would arise as a result of outdoor lighting.
As for the final Halacha, Hacham Ovadia Yosef ruled that one should preferably light the Hanukah candles outdoors in a glass box which protects it from the wind and rain. In this way, one can fulfill the Misva in the ideal fashion. Nevertheless, he adds, those who have the practice of lighting indoors, near a window, have authorities on whom to rely and may therefore continue this custom.
Interestingly enough, Hacham Ovadia cites amidst his discussion the counterintuitive ruling of the "Devar Yehoshua" who claimed that to the contrary, one should specifically light inside his home. In his view, once Jewish communities began lighting the Hanukah candles indoors due to the fear of arousing hostilities, this became the accepted, institutionalized practice from which one should not deviate even today. In fact, the "Devar Yehoshua" went so far as to claim that a person who lights outdoors does not fulfill his obligation, and the Berachot he recited before lighting are deemed "Berachot Le'vatala" (Berachot recited in vain). Since indoor lighting became the accepted manner of fulfilling this Misva, one who does otherwise does not fulfill his obligation.
Hacham Ovadia, however, resoundingly rejects this rationale, and rules that it is certainly permissible – and in fact preferable – to light outdoors.
Summary: In areas where there is no concern of potentially hostile gentiles, one should preferably light the Hanukah candles outdoors, in a glass box that protects the candles from the elements. Nevertheless, those who light indoors near a window have authorities on whom to rely.
