The Role of Human Capital in Imperfectly Informed International Financial Markets

HKIMR Working Paper No.09/2010

13 Pages Posted: 22 Jun 2010

See all articles by Isaac Ehrlich

Isaac Ehrlich

State University of New York at Buffalo - Department of Economics; National Bureau of Economic Research (NBER); University of Chicago - University of Chicago Press; Institute for the Study of Labor (IZA)

Jong Kook Shin

Korea University - Sejong Campus

Date Written: April 30, 2010

Abstract

The paper’s point of departure is that the information content of financial asset prices is formed partly through search for private information by individuals or investor groups, rather than gleaned exclusively from observed asset prices. Differences in the efficiency of search for information signals and in the opportunity costs involved lead to asymmetries in private information precision across investors and to variations in the price information content of traded assets. Our model links these variables to the level of prior knowledge, or “general human capital” investors possess concerning all traded assets, as well as idiosyncratic knowledge, or “specific human capital” associated with specific assets. In this context, the paper extends and generalizes the approach offered in Ehrlich, Hamlen and Yin (2008).

Pursuing a rational-expectations-equilibrium model of noisy prices with multiple assets and heterogeneous investors, we apply this model to explain the observed diversity in the degree of concentration of financial portfolios in domestic, relative to foreign assets across countries - what the literature has termed “home bias”. Our model predicts that while conditional increments in general human capital, proxied by schooling, monotonically increase the expected absolute holdings of both home and foreign stocks, “home bias” at the market level is an inverted-U function of schooling. Symmetrically opposite results are predicted concerning the impact of variations in the opportunity costs of information production, proxied by individual labor market wages. We test these predictions against aggregate market data concerning the compositions of aggregate portfolios across 23 countries over a 7-year period (2001-07). The results strongly support our discriminating hypotheses. A related, and more extensive, empirical investigation is contained in Ehrlich, Shin, and Yin (2010).

Suggested Citation

Ehrlich, Isaac and Shin, Jong Kook, The Role of Human Capital in Imperfectly Informed International Financial Markets (April 30, 2010). HKIMR Working Paper No.09/2010, Available at SSRN: https://ssrn.com/abstract=1628030 or http://dx.doi.org/10.2139/ssrn.1628030

Isaac Ehrlich (Contact Author)

State University of New York at Buffalo - Department of Economics ( email )

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Buffalo, NY 14260
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716-645 2127 (Fax)

HOME PAGE: http://arts-sciences.buffalo.edu/economics/faculty/faculty-directory/ehrlich.html

National Bureau of Economic Research (NBER) ( email )

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University of Chicago - University of Chicago Press ( email )

1427 E. 60th Street
Chicago, IL 60637
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Institute for the Study of Labor (IZA) ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Jong Kook Shin

Korea University - Sejong Campus ( email )

Sejong
Korea, Republic of (South Korea)

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