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 evidenc e on the home bias is provided and the question of why foreign exchang e risk or capital controls are not sufficient to explain the full effe ct is discussed. A simple noisy rational expectations model is introduc ed where, even in equilibrium, investors remain incompletely informed. It is shown that the domestic bias arises quite naturally when investor s are on average better informed about domestic stocks. Copyright 1993 by The editors of the Scandinavian Journal of Economics.