Asymmetric Information, Portfolio Managers and Home Bias

Abstract:     
Why do investors excessively tilt their portfolio towards domestic assets? Recent studies suggest asymmetric information plays a significant role in the home equity bias puzzle. A key assumption in theoretical models is that agents invest in assets and process information on their own. However, most international investments are executed by managers in financial institutions. These institutions allocate significant resources to processing information, making the asymmetric information assumption less appealing. In this paper, we explain home bias at the fund level by showing how information asymmetry at the individual level has relevant implications at the portfolio management level. Agents delegate their investment decisions to portfolio managers of different and uncertain ability. Investors are better informed about the performance of domestic markets; and therefore, are more able to evaluate the ability of managers operating in these markets. This, in turn, makes investing in domestic markets less risky and attracts more managers. Additionally, highly skilled managers benefit more from higher transparency, and this is why they are more likely to choose to operate in the domestic market. Therefore, a small information asymmetry of individual investors generates home bias due to highly skilled managers in the domestic market (higher than in the foreign market) and diversification (a higher number of managers in the domestic market). We simulate the model and find that on average 69.2% of investment is in the domestic market.

Number of Pages in PDF File: 26

Keywords: Equity Home Bias, Asymmetric Information, Fund Managers

working papers series