International Asset Allocation for Incompletely-informed Investors

In this study, we attempt to explain the home bias puzzle by examining the effect of information quality on the asset allocation decisions taken by agents under the assumption that two types of agents possess different information on the true expected returns of home and foreign assets. 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 foreign expected returns, those agents who are partially-informed and relatively more conservative will tend to hold fewer foreign assets than completelyinformed agents. We find that with an increase in the precision of the estimates of partially-informed agents, there is a corresponding reduction in the magnitude of their home bias. Finally, with an increase in the instantaneous correlation between the returns of the home and foreign assets, there is a similar corresponding decline in the magnitude of the home bias in the portfolios of partially-informed agents.