Asymmetric information and the lack of international portfolio diversifcation
By: Juan Carlos Hatchondo.
Contributors: Federal Reserve Bank of Richmond.
Series: Working paper ;; no. 05-7; Working paper (Federal Reserve Bank of Richmond : Online) ;; no. 05-7.
Publisher: Federal Reserve Bank of Richmond
Published: 2005
Place of publication: [Richmond, Va.]
Language: eng
Format: Electronic resource
Description: "There is pervasive evidence that individuals invest primarily in domestic assets and thus hold poorly diversifed portfolios. Empirical studies suggest that informational asymmetries may play a role in explaining the bias towards domestic assets. In contrast, theoretical studies based on asymmetric information fail to produce significant quantitative effects. The present paper develops a theoretical model in which the presence of informational asymmetries explains a significant fraction of the home equity bias observed in the data. The main departure from previous theoretical work is the assumption that local investors outperform foreign investors in identifying the correct ranking of local investment opportunities instead of possessing superior information about the aggregate performance of the domestic stock market. The other key assumption is based on the evidence that short-selling is a costly activity. This paper studies the case of a two-country world. There are two assets in each country. Only local investors receive informative signals about local assets. Thus, domestic agents have an incentive to concentrate their investments in the local asset favored by the signal realization, and reduce the position held in the other local asset. When the signal is sufficiently informative and short-sales are costly, local investors decide not to finance purchases of the perceived "good" local asset by selling short the perceived "bad" local asset. Instead they invest a lower fraction of their portfolio in foreign securities. This liberates resources that can be allocated in the local asset perceived to pay higher expected returns.."--Federal Reserve Bank of Richmond web site.
Notes: Includes bibliographical references.
Title from PDF file as viewed on Oct. 27, 2005.
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Mode of access: World Wide Web.