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Inside Information and the Own Company Stock Puzzle

Author

Listed:
  • Stijn Van Nieuwerburgh
  • Laura Veldkamp

Abstract

U.S. investors allocate 30-40% of their financial asset portfolio in the stock of the company they work for. Such a portfolio flies in the face of standard portfolio theory, which prescribes that an investor should hold less of a financial asset that is positively correlated with her undiversified labor income.Nevertheless, we propose a rational explanation that prescribes a long position in own company stock. Precisely because the own company stock is positively correlated with the investor's labor income, any information the investor learns about her earnings is a partial information advantage in her own company stock. When confronted with a choice of what information to acquire, employees may choose to learn about their own firm. Learning lowers the employee's risk of holding own-firm equity, which raises its risk-adjusted returns and makes a long position optimal.(JEL: F30, G11, D82) (c) 2006 by the European Economic Association.

Suggested Citation

  • Stijn Van Nieuwerburgh & Laura Veldkamp, 2006. "Inside Information and the Own Company Stock Puzzle," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 623-633, 04-05.
  • Handle: RePEc:tpr:jeurec:v:4:y:2006:i:2-3:p:623-633
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    Citations

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    Cited by:

    1. Ilona Babenko & Rik Sen, 2016. "Do Nonexecutive Employees Have Valuable Information? Evidence from Employee Stock Purchase Plans," Management Science, INFORMS, vol. 62(7), pages 1878-1898, July.
    2. Chen, XiaoHua & Lai, Yun-Ju, 2015. "On the concentration of mutual fund portfolio holdings: Evidence from Taiwan," Research in International Business and Finance, Elsevier, vol. 33(C), pages 268-286.
    3. Herskovic, Bernard & Kelly, Bryan & Lustig, Hanno & Van Nieuwerburgh, Stijn, 2016. "The common factor in idiosyncratic volatility: Quantitative asset pricing implications," Journal of Financial Economics, Elsevier, vol. 119(2), pages 249-283.
    4. Phelim Boyle & Lorenzo Garlappi & Raman Uppal & Tan Wang, 2012. "Keynes Meets Markowitz: The Trade-Off Between Familiarity and Diversification," Management Science, INFORMS, vol. 58(2), pages 253-272, February.
    5. Pavan, Alessandro & Vives, Xavier, 2015. "Information, Coordination, and Market Frictions: An Introduction," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 407-426.

    More about this item

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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