Information Immobility and the Home Bias Puzzle
38 Pages Posted: 3 Nov 2008
Date Written: July 2005
Many explanations for home or local bias rely on information asymmetry: investors know more about their home assets. A criticism of these theories is that asymmetry should disappearwhen information is tradable. This criticism is flawed. If investors have asymmetric prior beliefs, but choose how to allocate limited learning capacity before investing, they will not necessarily learn foreign information. Investors want to exploit increasing returns to specialization: The bigger the home information advantage, the more desirable are home assets; but the more home assets investors expect to own, the higher the value of additional home information. Even with a tiny home information advantage, and even when foreign information is no harder to learn, many investors will specialize in home assets, remain uninformed about foreign assets, and amplify their initial information asymmetry. The more investors can learn, the more home biased their portfolios become. The model's predictions are consistent with observed patterns of foreign investment, returns, and portfolio flows.
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