Juan Carlos Hatchondo () (Research Department Federal Reserve Bank of Richmond)
Abstract
There is pervasive evidence that individuals invest primarily in domestic assets and thus hold poorly diversified portfolios. Empirical studies suggest that informational asymmetries may play a role in explaining the bias towards domestic assets. In contrast, theoretical studies based on asymmetric information fail to produce significant quantitative effects. The present paper develops a theoretical model in which the presence of informational asymmetries explains a significant fraction of the home equity bias observed in the data. The main departure from previous theoretical work is the assumption that local investors outperform foreign investors in identifying the correct ranking of local investment opportunities instead of possessing superior information about the aggregate performance of the domestic stock market. The other key assumption is based on the evidence that short-selling is a costly activity. This paper studies the case of a two-country world. There are two assets in each country. Only local investors receive informative signals about local assets. Thus, domestic agents have an incentive to concentrate their investments in the local asset favored by the signal realization, and reduce the position held in the other local asset. When the signal is sufficiently informative and short-sales are costly, local investors decide not to finance purchases of the perceived ``good'' local asset by selling short the perceived ``bad'' local asset. Instead they invest a lower fraction of their portfolio in foreign securities. This liberates resources that can be allocated in the local asset perceived to pay higher expected returns
Download Info
To our knowledge, this item is not available for
download. To find whether it is available, there are three
options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page
whether it is in fact available.
3. Perform a search for a similarly titled item that would be
available.
Publisher Info
Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number
849.
Length: Date of creation: 03 Dec 2006 Date of revision: Handle: RePEc:red:sed006:849
Contact details of provider: Postal: Society for Economic Dynamics Anne Stubing CV Starr Center for Applied Economics 269 Mercer Street, Room 303 New York University New York, NY 10003 Fax: 1-860-486-4463 Email: Web page: http://www.EconomicDynamics.org/society.htm More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: (Christian Zimmermann).