Dynamic Information Acquisition and Portfolio Bias

Rosen Valchev

No 941, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: While international portfolios are still heavily biased towards home assets, the home bias has exhibited a clear downward trend in the last few decades. Interestingly, the underlying rise in foreign investment has been primarily directed to just a handful of OECD countries, and has not given rise to an across the board increase in all foreign investments. To understand the evolution of the home bias, this paper develops a dynamic model of information acquisition and portfolio choice. The dynamic framework introduces two new endogenous forces due to the fact that asset payoffs depend on the future asset prices and hence on the future information sets. First, there is a measure of endogenous unlearnable uncertainty in asset payoffs which generates decreasing returns to information when agents are sufficiently well informed about an asset, and hence gives a reason to diversify information and portfolios. In addition, the dynamic framework introduces a strategic complementarity in learning, due to the “beauty contest” of dynamic asset markets, which is absent in the benchmark static model where learning is purely a strategic substitute. As a result of both of these new endogenous forces, the model can explain the high overall level of the home bias, its decline over time and the fact that the rise in foreign investment has been coordinated on just a handful of destination countries. Moreover, the model predicts that the home bias decline is linked to the fall in information costs, and I find direct evidence of this in the data.

Keywords: Home Bias; Information Choice; Portfolio Choice; Dynamics (search for similar items in EconPapers)
JEL-codes: D8 D83 F3 G11 G15 (search for similar items in EconPapers)
Date: 2017-06-01
New Economics Papers: this item is included in nep-cse
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Citations: View citations in EconPapers (2)

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