Relative Optimism and the Home Bias Puzzle

Abstract

We study whether relative optimism leads to home bias in portfolio holdings for both equity and bonds by looking at two novel databases: a survey that includes expectations of identified professional asset management companies for equity, bonds and currencies, and the IMF portfolio holdings data for equity and bonds. We document that relative optimism for equity is persistent over the period 1997 to 2012, but relative optimism for bonds and currencies exhibits more time-series variation. Moreover, we show that relative optimism is an economically significant variable that helps explain home bias in portfolio holdings, not only for equity, but also for bonds.