Endogenous Acquisition of Information and the Equity Home Bias

Abstract

This paper investigates the extent to which differences in information costs can explain the equity home bias puzzle. In a model where information costs are higher for the Foreign asset than for the Home asset, we show that - if cost functions are convex and the assets have identical return characteristics - the expected size of the home bias in terms of differences in expected demands is positive and increasing in expected excess returns and risk, but decreasing in risk aversion. However, a calibration to US data suggests that information costs can explain only a small fraction of the observed home bias.