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On Asymmetric Information across Countries and the Home-Bias Puzzel

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  • Egil Matsen

    () (Department of Economics, Norwegian University of Science and Technology)

Abstract

This paper investigates the allocation decision of an investor who owns two projects, a domestic and a foreign one. A manager governs the expected return from each project, and the investor has less information on the actions of the foreign manager. The investor’s portfolio will be tilted relative to a situation with full information. With asymmetric information, he generally achieves a better risk-return characteristic of his net terminal wealth with an allocation different from full diversification, because a biased allocation can be beneficial to the managers’ efforts and/or risk properties of the optimal contracts. However, numerical simulations illustrate that, in general, the portfolio bias is small for plausible parameter values, and theoretically it may even be towards the foreign project. This weakens the case for asymmetric information as a prime reason for the observed home-bias in portfolio allocation.

Suggested Citation

  • Egil Matsen, 2001. "On Asymmetric Information across Countries and the Home-Bias Puzzel," Working Paper Series 0202, Department of Economics, Norwegian University of Science and Technology.
  • Handle: RePEc:nst:samfok:0202
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    File URL: http://www.svt.ntnu.no/iso/WP/2002/2MHHB_25_sep_00.pdf
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    References listed on IDEAS

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    1. Gordon, Roger H & Bovenberg, A Lans, 1996. "Why Is Capital So Immobile Internationally? Possible Explanations and Implications for Capital Income Taxation," American Economic Review, American Economic Association, vol. 86(5), pages 1057-1075, December.
    2. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
    3. Brennan, Michael J & Cao, H Henry, 1997. " International Portfolio Investment Flows," Journal of Finance, American Finance Association, vol. 52(5), pages 1851-1880, December.
    4. Tesar, Linda L. & Werner, Ingrid M., 1995. "Home bias and high turnover," Journal of International Money and Finance, Elsevier, vol. 14(4), pages 467-492, August.
    5. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
    6. Gehrig, Thomas, 1993. " An Information Based Explanation of the Domestic Bias in International Equity Investment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(1), pages 97-109.
    7. Cooper, Ian & Kaplanis, Evi, 1994. "Home Bias in Equity Portfolios, Inflation Hedging, and International Capital Market Equilibrium," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 45-60.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Asymmetric information; portfolio selection;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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