Working Paper

Home bias in financial markets: robust satisficing with info gaps

Abstract: The observed patterns of equity portfolio allocation around the world are at odds with predictions from a capital asset pricing model (CAPM). What has come to be called the ?home-bias? phenomenon is that investors tend to hold a disproportionately large share of their equity portfolio in home country stocks as compared with predictions of the CAPM. This paper provides an explanation of the home-bias phenomenon based on information-gap decision theory. The decision concept that is used here is that profit is satisficed and robustness to uncertainty is maximized rather than expected profit being maximized. Furthermore, uncertainty is modeled nonprobabilistically with info-gap models of uncertainty, which can be viewed as a possible quantification of Knightian uncertainty.

Bibliographic Information

Provider: Federal Reserve Bank of Atlanta

Part of Series: FRB Atlanta Working Paper

Publication Date: 2003

Number: 2003-35