Endogenous acquisition of information and the equity home bias

This paper investigates the extent to which differences in information costs can explain the equity home bias puzzle. In a model where information costs are higher for the Foreign asset than for the Home asset, I show that, if cost functions are convex and the assets have identical return characteristics, the expected size of the home bias in terms of differences in expected demands is positive and increasing in expected excess returns and risk, but decreasing in risk aversion. However, a calibration to US data suggests that information costs can explain only a small fraction of the observed home bias.