Asymmetric Information, Portfolio Managers and Home Bias

We propose a model of delegated asset management that can explain the following empirical regularities observed in international markets: (i) the presence of home bias, (ii) the lower proportion of mutual funds investing domestically, and (iii) the higher ability and market value of mutual funds investing domestically. In the model, heterogeneous fund managers choose whether to specialize in domestic or foreign assets. Individual investors are uncertain about managers' abilities to generate abnormal returns, and they are more informed about domestic markets than foreign markets. As a result, they are better able to evaluate the ability of managers who specialize in domestic assets. This makes domestic investments less risky and generates home bias. Home bias is magnified by the managers' specializations: since ability is rewarded more in the domestic market, higher ability managers invest domestically, making domestic assets more attractive to the investors.