International asset allocation for incompletely-informed investors

Abstract

This study explains the home bias puzzle by examining the effect of information quality on the asset allocation decisions. Our calibration results based on MSCI data indicate that in order to hedge for the changing quality of the information, when updating their estimates of expected returns of foreign assets, those agents who are partially informed and relatively more conservative will tend to hold fewer foreign assets than completely-informed agents. Furthermore, the magnitude of home bias in the portfolio of partially-informed agents decreases with the precision of their estimates and the instantaneous correlation between the returns of the home and foreign assets.