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

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  • Massimo Guidolin

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.

Suggested Citation

  • Massimo Guidolin, 2005. "Home bias and high turnover in an overlapping generations model with learning," Working Papers 2005-012, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2005-012
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    References listed on IDEAS

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    1. Geert Bekaert & Campbell R. Harvey, 2000. "Foreign Speculators and Emerging Equity Markets," Journal of Finance, American Finance Association, vol. 55(2), pages 565-613, April.
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    Cited by:

    1. Chan, Kalok & Covrig, Vicentiu, 2012. "What determines mutual fund trading in foreign stocks?," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 793-817.
    2. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock & Jon Wongswan, 2011. "US International Equity Investment and Past and Prospective Returns," American Economic Review, American Economic Association, vol. 101(7), pages 3440-3455, December.
    3. Massimo Guidolin & Francesca Rinaldi, 2013. "Ambiguity in asset pricing and portfolio choice: a review of the literature," Theory and Decision, Springer, vol. 74(2), pages 183-217, February.
    4. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock & Jon Wongswan, 2011. "U.S. international equity investment and past prospective returns," International Finance Discussion Papers 1016, Board of Governors of the Federal Reserve System (U.S.).
    5. Warnock, Francis E., 2002. "Home bias and high turnover reconsidered," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 795-805, November.
    6. Warnock, Francis E & Cleaver, Chad, 2003. "Financial Centres and the Geography of Capital Flows," International Finance, Wiley Blackwell, vol. 6(1), pages 27-59, Spring.

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    Keywords

    International finance ; Investments;

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