AN INFORMATION BASED EXPLANATION OF THE DOMESTIC BIAS IN INTERNATIONAL EQUITY INVESTMENT

The domestic bias in international equity investment presents a major challenge to asset pricing models building on the assumption of symmetrically informed investors. Some further evidence on the home bias is provided and the question of why foreign exchange risk or capital controls are not sufficient to explain the full effect is discussed. A simple noisy rational expectations model is introduced where, even in equilibrium, investors remain incompletely informed. It is shown that the domestic bias arises quite naturally when investors are on average better informed about domestic stocks.