Dynamic Information Acquisition and Home Bias in Portfolios

Rosen Valchev

No 1486, 2017 Meeting Papers from Society for Economic Dynamics

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. Understanding the decline could help us shed new light on the puzzle as a whole, and to this end this paper develops a dynamic model of endogenous information acquisition. Due to the presence of non-tradable income and the usual feedback between information and portfolio choice, agents find it optimal to specialize their information acquisition on domestic assets, leading to information asymmetry and home bias in equilibrium. The dynamic framework, however, also introduces a measure of endogenous unlearnable uncertainty, absent in a static model, which generates decreasing returns to information when agents are sufficiently well informed about an asset. As a result, the model can explain both the high overall level of the home bias, and its decline over time. The model makes a clear predictions that the home bias decline is linked to the fall in information costs, and I show that this is true in the data as well.

Date: 2017
New Economics Papers: this item is included in nep-dge
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