ASYMMETRIC INFORMATION AND THE LACK OF PORTFOLIO DIVERSIFICATION*

Authors

  • Juan Carlos Hatchondo

    1. Federal Reserve Bank of Richmond, U.S.A.
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    • 1

      This article is part of my dissertation at the University of Rochester. I am greatly indebted to Per Krusell for his encouragement and advice. This work has also benefited from comments and discussions with Rui Albuquerque, Irasema Alonso, Eva De Francisco, Margarida Duarte, Huberto Ennis, Fernando Leiva, Leonardo Martinez, Joseph Perktold, Martin Schneider, Alan Stockman, Paul Willen, and two referees. The project started while I was visiting the Institute for International Economic Studies at Stockholm University. I am grateful for their hospitality. The usual disclaimer applies. Any opinions expressed in this article are those of the author and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System. Please address correspondence to: J. C. Hatchondo, Research Department, Federal Reserve Bank of Richmond, 701 E. Byrd St., Richmond, VA 23261, U.S.A. Phone: 804-697-8076. Fax: 804-697-2662. E-mail: JuanCarlos.Hatchondo@rich.frb.org.


  • *

    Manuscript received Febraury 2007; revised June 2007.

Abstract

There is pervasive evidence that individuals invest primarily in local stocks and thus hold poorly diversified portfolios. The present article develops a theoretical model in which the presence of informational asymmetries introduces home equity bias. The main departure from previous theoretical work is the assumption that local investors outperform nonlocal investors in identifying the correct ranking of local investment opportunities, instead of possessing superior information about the aggregate performance of the local stock market. The second key assumption is based on the evidence that short-selling is a costly activity.

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