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Fear of the Unknown: Familiarity and Economic Decisions

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  • H. Henry Cao
  • Bing Han
  • David Hirshleifer
  • Harold H. Zhang

Abstract

Evidence indicates that people fear change and the unknown. We model this behavior as familiarity bias in which individuals focus on adverse scenarios in evaluating defections from the status quo. The model explains portfolio underdiversification, home and local biases. More importantly, equilibrium stock prices reflect an unfamiliarity premium. In an international setting, our model predicts that while the standard CAPM fails to hold with respect to the world market portfolio, a modified CAPM holds wherein the market portfolio is replaced with a portfolio of the stock holdings of investors not subject to familiarity bias. Copyright 2011, Oxford University Press.

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Bibliographic Info

Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 15 (2011)
Issue (Month): 1 ()
Pages: 173-206

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Handle: RePEc:oup:revfin:v:15:y:2011:i:1:p:173-206

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Citations

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Cited by:
  1. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9142, University Library of Munich, Germany.
  2. Siegel, Jordan I. & Licht, Amir N. & Schwartz, Shalom H., 2011. "Egalitarianism and international investment," Journal of Financial Economics, Elsevier, vol. 102(3), pages 621-642.
  3. Hui Chen & Nengjiu Ju & Jianjun Miao, . "Dynamic Asset Allocation with Ambiguous Return Predictability," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
  4. Baltzer, Markus & Stolper, Oscar & Walter, Andreas, 2011. "Home-field advantage or a matter of ambiguity aversion? Local bias among German individual investors," Discussion Paper Series 1: Economic Studies 2011,23, Deutsche Bundesbank, Research Centre.
  5. Goodell, John W. & Vähämaa, Sami, 2013. "US presidential elections and implied volatility: The role of political uncertainty," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 1108-1117.
  6. Salaber, Julie, 2013. "Religion and returns in Europe," European Journal of Political Economy, Elsevier, vol. 32(C), pages 149-160.
  7. Füllbrunn, Sascha & Rau, Holger & Weitzel, Utz, 2013. "Do ambiguity effects survive in experimental asset markets?," MPRA Paper 44700, University Library of Munich, Germany.
  8. Martin Schneider, 2010. "The Research Agenda: Martin Schneider on Multiple Priors Preferences and Financial Markets," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 11(2), April.

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