Review of Quantitative Finance and Accounting

, Volume 48, Issue 2, pp 527–556 | Cite as

Home bias in portfolio choices: social learning among partially informed agents

Original Research

Abstract

Using an ‘incomplete information’ model, we explore the role of social learning in the global portfolio choices of stock market investors. When partially informed followers attempt to estimate true domestic (home) mean returns, they likely acquire private domestic signals from partially informed leaders. However, the calibration results indicate the existence of home bias when partially informed agents have poor quality information. Partially informed agents are prone to a learning bias; they overreact to new domestic information due to overconfidence in their domestic private signals, but they demonstrate a conservative response to new information in foreign markets. Links between the private signals of partially informed agents may lead to correlated foreign investment strategies among such agents through social learning. We suggest the acquisition of private signals, along with the dissemination of information, affect international portfolio decision rules and are determinants of the phenomenon of home bias.

Keywords

Social learning International asset allocation Home bias Prior beliefs Observational learning 

JEL Classification

G11 

Notes

Acknowledgments

The authors would like to thank C. F. Lee (the editor), an anonymous referee, and the participants at The 2012 NTU International Conference on Finance, the 20th Conference on Securities and Financial Markets, the 2013 Annual Conference of Taiwan Finance Association, the 8th NCTU International Finance Conference, and the 22nd Annual Conference on Pacific Basin Finance, Economics, Accounting, and Management (PBFEAM) for many useful comments and suggestions on earlier drafts of this paper. Any remaining errors are our own. Wen-Lin Wu acknowledges the research grant of the Ministry of Science and Technology of Taiwan (NSC102-2410-H-035-011).

References

  1. Ahearne A, Griever W, Warnock F (2004) Information costs and home bias: an analysis of US holdings of foreign equities. J Int Econ 62:313–336CrossRefGoogle Scholar
  2. Avery C, Zemsky P (1998) Multidimensional uncertainty and herd behavior in financial markets. Am Econ Rev 88:724–748Google Scholar
  3. Back K (2004) Incomplete and asymmetric information in asset pricing theory. In: Frittelli M, Runggaldier W (eds) Stochastic methods in finance. Springer, Berlin, pp 1–25CrossRefGoogle Scholar
  4. Baele L, Pungulescu C, Ter Horst J (2007) Model uncertainty, financial market integration and the home bias puzzle. J Int Money Finance 26:606–630CrossRefGoogle Scholar
  5. Banerjee A (1992) A simple model of herd behavior. Q J Econ 107:797–817CrossRefGoogle Scholar
  6. Barber B, Odean T (2000) Trading is hazardous to your wealth: the common stock investment performance of individual investors. J Finance 55:773–806CrossRefGoogle Scholar
  7. Berrada T (2009) Bounded rationality and asset pricing with intermediate consumption. Rev Finance 13:693–725CrossRefGoogle Scholar
  8. Bihkchandani S, Hirshleifer D, Welch I (1992) A theory of fads, fashion, custom and cultural change as informational cascades. J Polit Econ 100:992–1026CrossRefGoogle Scholar
  9. Brandt M, Zeng Q, Zhang L (2004) Equilibrium stock return dynamics under alternative rules of learning about hidden states. J Econ Dyn Control 28:1925–1954CrossRefGoogle Scholar
  10. Brennan MJ (1998) The role of learning in dynamic portfolio decisions. Eur Finance Rev 1:295–306CrossRefGoogle Scholar
  11. Brennan M, Cao H (1997) International portfolio investment flows. J Finance 52:1858–1880CrossRefGoogle Scholar
  12. Brown J, Ivkovic Z, Smith P, Weisbenner S (2008) Neighbors matter: causal community effects and stock market participation. J Finance 63:1509–1531CrossRefGoogle Scholar
  13. Cao H, Han B, Hirshleifer D (2011) Taking the road less traveled by: does conversation eradicate pernicious cascades? J Econ Theory 146:1418–1436CrossRefGoogle Scholar
  14. Chiou P, Lee C-F (2013) Do investors still benefit from culturally home-biased diversification? An empirical study of China, Hong Kong, and Taiwan. Rev Quant Finance Acc 40:341–381CrossRefGoogle Scholar
  15. Chopra V, Ziemba W (1993) The effect of errors in means, variances, and covariances on optimal portfolio choice. J Portf Manag 19:6–11CrossRefGoogle Scholar
  16. Colla P, Mele A (2010) Information linkages and correlated trading. Rev Finance Stud 23:203–246CrossRefGoogle Scholar
  17. Cooper I, Sercu P, Vanpee R (2013) The equity home bias puzzle: a survey. Found Trends Finance 7:289–416CrossRefGoogle Scholar
  18. Coval J, Moskowitz T (2001) The geography of investment: informed trading and asset prices. J Polit Econ 109:811–841CrossRefGoogle Scholar
  19. Cronqvist H (2006) Advertising and portfolio choice. Working PaperGoogle Scholar
  20. DeMarzo P, Kaniel R, Kremer I (2004) Diversification as a public good: community effects in portfolio choice. J Finance 59:1677–1716CrossRefGoogle Scholar
  21. Detemple J (1986) Asset pricing in a production economy with incomplete information. J Finance 41:383–391CrossRefGoogle Scholar
  22. Dothan MU, Feldman D (1986) Equilibrium interest rates and multiperiod bonds in a partially observable economy. J Finance 41:369–382CrossRefGoogle Scholar
  23. Eyster E, Rabin M (2011) Rational observational learning. Working PaperGoogle Scholar
  24. Feldman D (2003) The term structure of interest rates: bounded or falling? Eur Finance Rev (Rev Finance) 7:103–113CrossRefGoogle Scholar
  25. Feldman D (2007) Incomplete information equilibria: separation theorems and other myths. Ann Oper Res 151:119–149CrossRefGoogle Scholar
  26. Foad H (2011) Immigration and equity home bias. J Int Money Finance 30:982–998CrossRefGoogle Scholar
  27. French K, Poterba J (1991) Investor diversification and international equity markets. Am Econ Rev 81:222–226Google Scholar
  28. Frijns B, Lai Q, Tourani-Rad A (2014) Institutional trading and stock returns: evidence from China. Rev Pac Basin Finance Mark Pol 17:1–26Google Scholar
  29. Gau Y-F, Hua M, Wu W-L (2010) International asset allocation for incompletely-informed investors. J Finance Mark 13:422–447CrossRefGoogle Scholar
  30. Gehrig T (1993) An information-based explanation of the domestic bias in international equity. Scand J Econ 95:97–109CrossRefGoogle Scholar
  31. Gelos R, Wei S (2005) Transparency and international portfolio holdings. J Finance 60:2987–3020CrossRefGoogle Scholar
  32. Graham J (1999) Herding among investment newsletters: theory and evidence. J Finance 54:237–268CrossRefGoogle Scholar
  33. Grinblatt M, Keloharju M (2001) How distance, language, and culture influence stockholdings and trades. J Finance 56:1053–1073CrossRefGoogle Scholar
  34. Hirshleifer D, Luo GY (2001) On the survival of overconfident traders in a competitive securities market. J Finance Mark 4:73–84CrossRefGoogle Scholar
  35. Hirshleifer D, Teoh SH (2003) Herd behavior and cascading in capital markets: a review and synthesis. Eur Finance Manag 9:25–66CrossRefGoogle Scholar
  36. Hong H, Kubik J, Stein J (2004) Social interaction and stock-market participation. J Finance 59:137–163CrossRefGoogle Scholar
  37. Hong H, Kubik J, Stein J (2005) Thy neighbor’s portfolio: word-of-mouth effects in the holdings and trades of money managers. J Finance 60:2801–2824CrossRefGoogle Scholar
  38. Huberman G (2001) Familiarity breeds investment. Rev Finance Stud 14:659–680CrossRefGoogle Scholar
  39. Ivković Z, Weisbenner S (2005) Local does as local is: information content of the geography of individual investors’ common stock investments. J Finance 60:267–306CrossRefGoogle Scholar
  40. Ivković Z, Weisbenner S (2007) Information diffusion effects in individual investors’ common stock purchases: covet thy neighbors’ investment choices. Rev Finance Stud 20:1327–1357CrossRefGoogle Scholar
  41. Juneja J (2015) An evaluation of alternative methods used in the estimation of Gaussian term structure models. Rev Quant Finance Acc 44:1–24CrossRefGoogle Scholar
  42. Kang J, Stulz R (1997) Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan. J Finance Econ 46:3–28CrossRefGoogle Scholar
  43. Karlsson A, Norden L (2007) Home sweet home: home bias and international diversification among individual investors. J Bank Finance 31:317–333CrossRefGoogle Scholar
  44. Kaustia M, Knupfer S (2012) Peer performance and stock market entry. J Finance Econ 104:321–338CrossRefGoogle Scholar
  45. Kilka M, Weber M (2000) Home bias in international stock return expectations. J Behav Finance 1:176–192Google Scholar
  46. Korniotis G, Kumar A (2013) Do portfolio distortions reflect superior information or psychological biases? J Finance Quant Anal 48:1–48CrossRefGoogle Scholar
  47. Kuvvet E (2013) Threats to foreign equity investments in international capital markets: nationalism and militarism. Rev Pac Basin Finance Mark Pol 16:1–16Google Scholar
  48. Lang M, Lins K, Miller D (2003) ADRs, analysts, and accuracy: does cross listing in the United States improve a firm’s information environment and increase market value? J Acc Res 41:317–345CrossRefGoogle Scholar
  49. Lewis K (1999) Trying to explain home bias in equity and consumption. J Econ Lit 37:571–608CrossRefGoogle Scholar
  50. Li K (2004) Confidence in the familiar: an international perspective. J Finance Quant Anal 39:47–68CrossRefGoogle Scholar
  51. Liptser RS, Shiryaev AN (2001) Statistics of random process I and II. Springer, BerlinCrossRefGoogle Scholar
  52. Lundtofte F (2006) The effect of information quality on optimal portfolio choice. Finance Rev 41:157–185CrossRefGoogle Scholar
  53. Lundtofte F (2013) The quality of public information and the term structure of interest rates. Rev Quant Finance Acc 40:715–740CrossRefGoogle Scholar
  54. Lutje T, Menkhoff L (2007) What drives home bias? Evidence from fund managers’ views. Int J Finance Econ 12:21–35CrossRefGoogle Scholar
  55. Merton R (1980) On estimating the expected return on the market: an explanatory investigation. J Finance Econ 8:323–361CrossRefGoogle Scholar
  56. Mishra AV (2011) Australia’s equity home bias and real exchange rate volatility. Rev Quant Finance Acc 37:223–244CrossRefGoogle Scholar
  57. Mishra AV, Conteh UB (2014) Australia’s bond home bias. Rev Pac Basin Finance Mark Pol 17:1–30Google Scholar
  58. Ng L, Wu F (2010) Peer effects in the trading decisions of individual investors. Finance Manag 39:807–831CrossRefGoogle Scholar
  59. Nosic A, Weber M, Glaser M (2011) Opening the black box: from an individual bias to portfolio performance. Working PaperGoogle Scholar
  60. Ozsoylev H (2007) Asset pricing implications of social networks. Working PaperGoogle Scholar
  61. Park A, Sabourian H (2011) Herding and contrarian behavior in financial markets. Econometrica 79:973–1026CrossRefGoogle Scholar
  62. Parwada J, Yang J (2009) Information diffusion among international fund managers: multicountry evidence. Finance Manag 38:817–835CrossRefGoogle Scholar
  63. Portes R, Rey H (2005) The determinants of cross-border equity flows. J Int Econ 65:269–296CrossRefGoogle Scholar
  64. Riedel F (2000) Decreasing yield curves in a model with an unknown constant growth rate. Eur Finance Rev (Rev Finance) 4:51–67CrossRefGoogle Scholar
  65. Stone D, Miller S (2013) Learning, leading and herding. Math Soc Sci 65:222–231CrossRefGoogle Scholar
  66. Strong N, Xu X (2003) Understanding the equity home bias: evidence from survey data. Rev Econ Stat 85:307–312CrossRefGoogle Scholar
  67. Van Nieuwerburgh S, Veldkamp L (2009) Information immobility and the home bias puzzle. J Finance 64:1187–1215CrossRefGoogle Scholar
  68. Welch I (1992) Sequential sales, learning, and cascades. J Financ 47:695–732CrossRefGoogle Scholar
  69. Zhu N (2002) The local bias of individual investors. Yale ICF Working Paper No. 02–30Google Scholar

Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  1. 1.Department of International TradeFeng Chia UniversityTaichung CityTaiwan, ROC
  2. 2.Department of FinanceNational Central UniversityTaoyuan CityTaiwan, ROC

Personalised recommendations