Familiarity Breeds Investment

Abstract (Via Huberman)

The geographic distribution of the shareholders of the U.S. Regional Bell Operating Companies (RBOCs) indicates that a customer of an RBOC is more likely to invest in his local company than in an RBOC in another service area. Holdings of the local RBOC tend to be larger than investments in RBOCs that serve other areas. The geographic bias of the RBOC investors is closely related to the general tendency of households’ portfolios to be concentrated, of employees’ tendency to own their employers’ stocks in their retirement accounts, and to the home country bias in the international arena. Together, these phenomena provide compelling evidence that people invest in the familiar while often ignoring the principles of portfolio theory. Survey results point in the same direction, and suggest that wishful thinking plays a role in portfolio allocation.

Introduction (Via Huberman)

Rational investors will greatly benefit from international diversification. Nonetheless, people tend to ignore this advice: by and large, investors’ money stays in their home countries. Kang and Stulz (1997) observe: “Many Financial Economists have noticed that even though the barriers to international investment have fallen dramatically, foreign ownership of shares is still extremely limited and much smaller than one would expect in the absence of barriers to international investment.” An article in the Economist (1996), “Stay-at-Home Shareholders,” concludes: “It appears, therefore, that foreign investment has been hampered, at least until recently, by many of the factors that common sense would suggest: capital controls, opaque markets, and the high cost for fund managers of setting up overseas. In the past few years, these barriers have been falling—especially in emerging markets, where the gains from diversifying are biggest. So investors should soon start gobbling up foreign shares in record numbers. If they do not, economists may have to diversify into other theories.” A novel explanation of the home country bias is that people simply prefer to invest in the familiar. People root for the home team, and feel comfortable investing their money in a business that is visible to them. Paucity of international diversification is only one of the implications of this tendency to invest in the familiar.

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30. January 2010 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

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