Working Paper

Foreign stock holdings: the role of information

Abstract: The household finance literature documents a large fraction of the population not participating in stock markets. It is also puzzling that a much greater share of households do not participate in foreign stock markets. Recent empirical evidence points towards the role of information in determining agents' portfolio choices. I test these results into a model that incorporates information on agents' portfolio allocation decision. In the model, consumers can invest in both domestic and foreign stocks and to update their information set, agents have to pay a cost implying that consumers update their portfolio only infrequently. In addition, to account for the initial costs of acquiring information about stock investments, a version of the model also features an entry-cost to be paid at the first period by agents that decide to enter stock market. Agents that invest in foreign stocks are more attentive, updating their portfolio more frequently. After calibrating the model to match returns and volatility for the U.S. economy and dierent foreign stock investments, I obtain that the minimum entry cost necessary to drive households completely out of stock markets is large (and in line with the equity premium puzzle literature). However, once agents already invest in domestic stock markets, the minimum cost that would drive investors out of foreign stocks market is much smaller. The size of the latter minimum entry cost depends on model parameters assumptions, and small variations on risk aversion and uncertaintly about foreign asset returns can bring this entry cost down enough to justify the substancial non-participation in foreign stock markets.

Keywords: Stockholders; Stock market;

Bibliographic Information

Provider: Federal Reserve Bank of San Francisco

Part of Series: Working Paper Series

Publication Date: 2010

Number: 2010-26