A Global Equilibrium Asset Pricing Model with Home Preference

38 Pages Posted: 6 Mar 2011 Last revised: 8 Nov 2011

Bruno Solnik

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Luo Zuo

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: March 5, 2011

Abstract

We develop a global equilibrium asset pricing model assuming that investors suffer from foreign aversion, a preference for home assets based on familiarity. Using a utility formulation inspired by regret theory, we derive closed-form solutions. When the degree of foreign aversion is high in a given country, investors place a high valuation on domestic equity, which results in a lower expected return. Thus, the model generates the simple prediction that a country’s degree of home bias and the expected return of its domestic assets should be inversely related. Our predicted relation between the degree of home bias and a country’s expected return has the opposite sign predicted by models that assume some form of market segmentation. Using IMF portfolio data we find that expected returns are negatively related to home bias.

Keywords: International Asset Pricing, Home Bias, Familiarity, Regret

JEL Classification: G12, G15

Suggested Citation

Solnik, Bruno and Zuo, Luo, A Global Equilibrium Asset Pricing Model with Home Preference (March 5, 2011). Available at SSRN: https://ssrn.com/abstract=1778662 or http://dx.doi.org/10.2139/ssrn.1778662

Bruno Solnik (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

Luo Zuo

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

349 Sage Hall
Ithaca, NY 14853
United States
607-255-4002 (Phone)

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile/id/lz352

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