Private Information, Human Capital, andOptimal “Home Bias” in Financial Markets

By allowing for imperfectly informed markets and the role of private information, we offer newinsights about observed deviations of portfolio concentrations in domestic relative to foreignrisky assets, or “home bias”, from what standard finance models predict. Our model ascribesthe “bias” to endogenous information acquisition bolstered by investors’ human capital. Wedevelop discriminating hypotheses about the influence of “specific” and “general” humancapital endowments and direct and opportunity costs of managing risky assets in determiningwhether to hold these assets, and how the assets’ portfolio shares vary across investors andfinancial markets. These hypotheses are supported by numerical and econometric analysesof panel data from the US over 1992-2007, and 23 international financial markets over 2001-2007. The results indicate the existence of differences across countries in the degree towhich home asset prices are “information-revealing”, which may be relevant for fullyunderstanding the global financial crisis of 2007-09....