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Does asymmetric information cause the home equity bias?

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  • Bravo-Ortega, Claudio

Abstract

The home equity bias is one of the many puzzles existing in international finance. This puzzle is characterized by the concentration of domestic equity in any investor's portfolio, which is in contradiction with the benchmark of full diversification in a world mutual fund. Based on Admati's (1985) and Gehrig's (1993) noisy rational expectation models, the author tries to explain the effect of asymmetric information in the home equity bias puzzle. While asymmetric information helps to explain the puzzle for the case of one domestic, and one foreign equity, this result relies on very restrictive assumptions. Using a model with one domestic asset and two foreign assets, the author illustrates that asymmetries of information are also consistent with home equity bias reversals. One proposition generalizes these results. Simulations corroborate the main theoretical predictions of the model presented by the author.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 3495.

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Date of creation: 01 Jan 2005
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Handle: RePEc:wbk:wbrwps:3495

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Keywords: Payment Systems&Infrastructure; Economic Theory&Research; Financial Intermediation; International Terrorism&Counterterrorism; Environmental Economics&Policies; International Terrorism&Counterterrorism; Economic Theory&Research; Environmental Economics&Policies; Financial Intermediation; Insurance Law;

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  1. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, Elsevier, vol. 14(4), pages 467-492, August.
  2. Michaelides, Alexander, 2003. "International portfolio choice, liquidity constraints and the home equity bias puzzle," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 28(3), pages 555-594, December.
  3. Lewis, Karen K., 2000. "Why do stocks and consumption imply such different gains from international risk sharing?," Journal of International Economics, Elsevier, Elsevier, vol. 52(1), pages 1-35, October.
  4. John Heaton & Deborah Lucas, 2000. "Portfolio Choice and Asset Prices: The Importance of Entrepreneurial Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 55(3), pages 1163-1198, 06.
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  6. Shlomo Benartzi, 2001. "Excessive Extrapolation and the Allocation of 401(k) Accounts to Company Stock," Journal of Finance, American Finance Association, American Finance Association, vol. 56(5), pages 1747-1764, October.
  7. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  8. Joshua D. Coval & Tobias J. Moskowitz, 1999. "Home Bias at Home: Local Equity Preference in Domestic Portfolios," Journal of Finance, American Finance Association, American Finance Association, vol. 54(6), pages 2045-2073, December.
  9. Harald Hau, 2001. "Location Matters: An Examination of Trading Profits," Journal of Finance, American Finance Association, American Finance Association, vol. 56(5), pages 1959-1983, October.
  10. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262150476, December.
  11. Alexander Michaelides, 2003. "International portfolio choice, liquidity constraints and the home equity bias puzzle," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 195, London School of Economics and Political Science, LSE Library.
  12. Shujing Li & Hamid Faruqee & Isabel K. Yan, 2004. "The Determinants of International Portfolio Holdings and Home Bias," IMF Working Papers, International Monetary Fund 04/34, International Monetary Fund.
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