Private Information, Human Capital, and Optimal 'Home Bias' in Financial Markets

Abstract

By allowing for imperfectly informed markets but optimal private information acquisition, we offer new insights about observed variations in portfolio con- centrations in domestic versus foreign risky assets, or “home bias,” and the degree to which home asset prices are “information revealing.” Our model produces discriminating hypotheses about the role of “specific” and “general” human capital endowments and opportunity costs of managing risky assets in deter- mining whether to hold these assets and how their portfolio shares vary across heterogeneous investors and financial markets. These hypotheses are supported by numerical and econometric analyses of panel data from the United States and 23 international financial markets.