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Home bias and high turnover in an overlapping generations model with learning

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Massimo Guidolin

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Abstract

This paper develops a two-country OLG model under the assumption that investors are on a Bayesian learning path. While investors from both countries receive identical information flows, domestic investors start off with less precise prior beliefs concerning foreign fundamentals. On a learning path, differences in beliefs and estimation risk generate portfolio biases similar to those observed empirically: home bias in equity portfolios and trend-chasing in international flows. In addition, due to the higher volatility of the estimates of foreign state variables, our model produces excessive turnover in foreign securities as reported by Tesar and Werner (1995). We use real GDP data for the US and Europe to calibrate the model and produce simulations that show that under the assumption of a financial liberalization during the 1970s, substantial home bias and excess turnover should have been observed in the subsequent years.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2005-012.

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Date of creation: 2005
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Publication status: Published in Review of International Economics, September 2005, 13(4), pp. 725-56
Handle: RePEc:fip:fedlwp:2005-012

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Keywords: International finance ; Investments;

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  4. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June. [Downloadable!] (restricted)
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  6. Spiegel, Matthew, 1998. "Stock Price Volatility in a Multiple Security Overlapping Generations Model," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(2), pages 419-47.
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Francis E. Warnock, 2001. "Home bias and high turnover reconsidered," International Finance Discussion Papers 702, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Francis E. Warnock & Chad Cleaver, 2002. "Financial centers and the geography of capital flows," International Finance Discussion Papers 722, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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