Foreign Stocks Holding: The Role of Information

Abstract

Foreign stock ownership is known to be very limited across households. This paper studies the role of information acquisition on agents' decisions to invest in foreign stocks. Using the Survey of Consumer Finances, I show that foreign stock holders, when compared to those who hold only domestic stocks, are substantially wealthier, more educated, have a different age profile, and more importantly, are more sophisticated in their sources of information. Households that participate in foreign stock markets are better informed about their financial investment choices; they shop more for investments, update their investment portfolios more frequently, and use the Internet more often as a source of information. To account for the two main features of the data -- that foreign stock owners are scarce but better-informed -- the paper considers a model where information is costly, and investors decide whether to enter the domestic and foreign stock markets. In the model, investors pay a fixed cost to update their information set, implying infrequent updating. To account for the low participation, the model also features an entry cost paid when agents first invest in stocks. The model predicts that those who invest in foreign stocks update their information set more frequently. A version of the model calibrated to match returns and volatility for U.S. and foreign stock investments shows that, once agents already invest in domestic stock markets, the minimum entry cost needed to drive agents out of foreign stock markets is potentially small helping to explain the large nonparticipation.