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Home bias in financial markets: robust satisficing with info gaps

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  • Yakov Ben-Haim
  • Karsten Jeske
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    Abstract

    The observed patterns of equity portfolio allocation around the world are at odds with predictions from a capital asset pricing model (CAPM). What has come to be called the “home-bias” phenomenon is that investors tend to hold a disproportionately large share of their equity portfolio in home country stocks as compared with predictions of the CAPM. This paper provides an explanation of the home-bias phenomenon based on information-gap decision theory. The decision concept that is used here is that profit is satisficed and robustness to uncertainty is maximized rather than expected profit being maximized. Furthermore, uncertainty is modeled nonprobabilistically with info-gap models of uncertainty, which can be viewed as a possible quantification of Knightian uncertainty.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2003-35.

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    Date of creation: 2003
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    Handle: RePEc:fip:fedawp:2003-35

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    1. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    2. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
    3. Kenneth R. French & James M. Poterba, 1991. "Investor Diversification and International Equity Markets," NBER Working Papers 3609, National Bureau of Economic Research, Inc.
    4. Epstein, Larry G & Wang, Tan, 1994. "Intertemporal Asset Pricing Under Knightian Uncertainty," Econometrica, Econometric Society, vol. 62(2), pages 283-322, March.
    5. Karsten Jeske, 2001. "Equity home bias: Can information cost explain the puzzle?," Economic Review, Federal Reserve Bank of Atlanta, issue Q3, pages 31-42.
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    Cited by:
    1. Yakov Ben-Haim, 2007. "Info-Gap Robust-Satisficing and the Probability of Survival," DNB Working Papers 138, Netherlands Central Bank, Research Department.

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