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A Global Equilibrium Asset Pricing Model with Home Preference

Author

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  • Bruno Solnik

    () (Department of Finance, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong; and HEC Paris, 78350 Jouy en Josas, France)

  • Luo Zuo

    () (Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts 02142)

Abstract

We develop a global equilibrium asset pricing model assuming that investors suffer from foreign aversion, a preference for home assets based on familiarity. Using a utility formulation inspired by regret theory, we derive closed-form solutions. When the degree of foreign aversion is high in a given country, investors place a high valuation on domestic equity, which results in a low expected return. Thus, the model generates the simple prediction that a country's degree of home bias and the expected return of its domestic assets should be inversely related. Our predicted relation between the degree of home bias and a country's expected return has the opposite sign predicted by models that assume some form of market segmentation. Using International Monetary Fund portfolio data, we find that expected returns are negatively related to home bias. This paper was accepted by Brad Barber, Teck Ho, and Terrance Odean, special issue editors.

Suggested Citation

  • Bruno Solnik & Luo Zuo, 2012. "A Global Equilibrium Asset Pricing Model with Home Preference," Management Science, INFORMS, vol. 58(2), pages 273-292, February.
    • Handle: RePEc:inm:ormnsc:v:58:y:2012:i:2:p:273-292
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    File URL: http://dx.doi.org/10.1287/mnsc.1110.1361
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Mishra, Anil V., 2016. "Foreign bias in Australian-domiciled mutual fund holdings," Pacific-Basin Finance Journal, Elsevier, vol. 39(C), pages 101-123.
    2. da Gama Batista, João & Massaro, Domenico & Bouchaud, Jean-Philippe & Challet, Damien & Hommes, Cars, 2017. "Do investors trade too much? A laboratory experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 140(C), pages 18-34.
    3. repec:eee:inecon:v:113:y:2018:i:c:p:74-105 is not listed on IDEAS
    4. repec:eee:revfin:v:33:y:2017:i:c:p:41-54 is not listed on IDEAS
    5. Roee Teper, 2010. "Probabilistic Dominance and Status Quo Bias," Working Paper 5864, Department of Economics, University of Pittsburgh.
    6. Huang, Yuqin & Qiu, Huiyan & Wu, Zhiguo, 2016. "Local bias in investor attention: Evidence from China's Internet stock message boards," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 338-354.
    7. Riella, Gil & Teper, Roee, 2014. "Probabilistic dominance and status quo bias," Games and Economic Behavior, Elsevier, vol. 87(C), pages 288-304.
    8. Hill, Brian & Michalski, Tomasz, 2018. "Risk versus ambiguity and international security design," Journal of International Economics, Elsevier, vol. 113(C), pages 74-105.
    9. Korn, Olaf & Rieger, Marc Oliver, 2016. "Hedging with regret," CFR Working Papers 16-06, University of Cologne, Centre for Financial Research (CFR).
    10. Dodd, Olga & Frijns, Bart, 2015. "Cross-listing decisions and the foreign bias of investors," Finance Research Letters, Elsevier, vol. 15(C), pages 160-166.

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