Human Capital and Imperfectly Informed Financial Markets

6 Pages Posted: 24 Aug 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: August 20, 2010

Abstract

Deviating from conventional models in financial economics which maintain that markets are perfectly informed, more recent work has relied on the role of private information to explain observed portfolio choices or their impact on market outcomes in financial and currency markets (see, e.g., Philippe Bacchetta and Eric Van Wincoop 2006, and Stijin Van Nieuwerburgh and Laura Veldkamp 2009). These studies have not offered, however, a testable model of endogenous information acquisition. Following Isaac Ehrlich, William A. Hamlen Jr., and Yong Yin (2008), we here pursue such a model, based on the role of human capital in information production, and test its power to explain variations in “home bias” - the holding of home, relative to foreign, stocks - across international markets.

There is an extensive literature in financial economics that offers various explanations for “home bias.” What we add to these studies is the role of prior knowledge and private information acquisition in imperfectly informed markets. Our model of endogenous information acquisition, or “asset management” (cf. Ehrlich and Uri Ben-Zion 1976), relies on heterogeneity in individuals’ human capital endowments - both “general” and “specific” - to explain evidence on diversity in home bias at both the micro and macro levels in a multi-asset framework. Our model predicts that while a conditional increase in general human capital, proxied by schooling, increases the expected absolute demand for both home and foreign stocks, “home bias” at the market level is an inverted-U function of schooling. This prediction is confirmed in our empirical investigation.

Suggested Citation

Ehrlich, Isaac and Shin, Jong Kook, Human Capital and Imperfectly Informed Financial Markets (August 20, 2010). American Economic Review: Papers & Proceedings, Vol. 100, pp. 244–249, May 2010, Available at SSRN: https://ssrn.com/abstract=1662587

Isaac Ehrlich (Contact Author)

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

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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 )

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Institute for the Study of Labor (IZA) ( email )

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Bonn, D-53072
Germany

Jong Kook Shin

Korea University - Sejong Campus ( email )

Sejong
Korea, Republic of (South Korea)

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