NCPA - National Center for Policy Analysis

Investing in The Familiar

July 25, 2002

When making investment decisions, people tend to prefer domestic securities. Americans hold 93 percent of their equity investments in domestic stocks. This "home-bias" contradicts portfolio theory and has been attributed to the trading costs and lack of transparency that make it difficult to buy foreign securities.

If portfolio theory were the case, we would expect little bias within a country. But this is not the case, according to a recent study by Gur Huberman of Columbia University. Huberman analyzes the holdings of equity in local telephone companies (Regional Bell Operating Companies or RBOCs) in the year 1996, and finds that "home-bias" is quite evident within the United States.

  • There are twice as many investment accounts held in local RBOCs than held in out-of-state RBOCs.
  • The fraction of locally held RBOC stock is almost three times higher than the fraction of out-of-state equity held in that state.
  • The average amounts invested in local RBOCs are surprisingly large, ranging from $10,000 to $20,000, and contradict the principle of risk diversification, since the stock of local RBOCs is highly correlated with the local economic performance.
  • Huberman thinks that this "home-bias" is the result of a preference to invest in the familiar, rather than the fact that people have more information about local markets.

The most extreme form of home bias is investment in an employer's stock. Not even financially sophisticated investors are an exception: 19 percent of J.P. Morgan employees' retirement savings are in the company, despite the lack of incentives to buy it.

Source: "Investing in the familiar," Economic Intuition, Fall 2001; based on Gur Huberman, "Familiarity Breeds Investment," Review of Financial Studies, Fall 2001.

For study text

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=199314

 

Browse more articles on Economic Issues