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Fear of the Unknown: Familiarity and Economic Decisions

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  • Cao, Henry
  • Han, Bing
  • Hirshleifer, David
  • Zhang, Harold

Abstract

Evidence indicates that people fear change and the unknown. We offer a model of familiarity bias in which individuals focus on adverse scenarios in evaluating defections from the status quo. The model explains the endowment effect, portfolio underdiversification, home and local biases. Equilibrium stock prices reflect an unfamiliarity premium. In an international setting, our model implies that the absolute pricing error of the standard CAPM is positively correlated with the amount of home bias. It also predicts that a modified CAPM holds wherein the market portfolio is replaced with a portfolio of the stock holdings of investors not subject to familiarity bias.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 6512.

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Date of creation: 2007
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Handle: RePEc:pra:mprapa:6512

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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. Hui Chen & Nengjiu Ju & Jianjun Miao, . "Dynamic Asset Allocation with Ambiguous Return Predictability," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
  3. Füllbrunn, Sascha & Rau, Holger & Weitzel, Utz, 2013. "Do ambiguity effects survive in experimental asset markets?," MPRA Paper 44700, University Library of Munich, Germany.
  4. 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.
  5. 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.
  6. 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.
  7. Salaber, Julie, 2013. "Religion and returns in Europe," European Journal of Political Economy, Elsevier, vol. 32(C), pages 149-160.
  8. 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.

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