Home Bias in Financial Markets: Robust Satisficing with Info Gaps

Yakov Ben-Haim and Karsten Jeske
Working Paper 2003-35
December 2003

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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.

JEL classification: D81, F30, G11, G15

Key words: equity home bias, Knightian uncertainty

The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Yakov Ben-Haim, Faculty of Mechanical Engineering, Technion-Israel Institute of Technology, Haifa 32000 Israel, yakov@technion.ac.il, or Karsten Jeske, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, NE, Atlanta, GA 30309-4470, 404-498-8825, karsten.jeske@atl.frb.org.