Individual Home Bias, Portfolio Churning and Performance

Abstract

This study investigates economic consequences of individual investors’ home bias and portfolio churning in their personal pension accounts. The empirical analysis is carried out within a Heckman style two-stage framework to account for selection bias with respect to individuals’ investment activity, and to allow for an endogenously determined home bias, portfolio churning, and performance. Results indicate that home bias induces a worse risk-adjusted performance. Home biased individuals’ relatively bad performance originates in insufficient risk-reduction, due to a lack of international diversification. A higher degree of portfolio churning also deteriorates performance, despite the fact that churning is not associated with any direct transactions costs. However, home biased individuals do not churn portfolios as often as individuals with a larger share of international asset holdings, which diminishes the negative effects of home bias on performance. Overconfidence is driven by a return-chasing behavior, where overconfident individuals favor international assets with high historical returns. Individuals with actual skill are more often men than women, are not tempted by high historical returns, and use international assets for the right reason – diversification.