Investor Competence, Trading Frequency, and Home Bias

Abstract

People are more willing to bet on their own judgments when they feel skillful or knowledgeable (Heath and Tversky (1991)). We investigate whether this "competence effect" influences trading frequency and home bias. We find that investors who feel competent trade more often and have a more internationally diversified portfolio. We also find that male investors, and investors with higher income or more education, are more likely to perceive themselves as competent investors than are female investors, and investors with lower income or less education. Our results are unlikely to be explained by other hypotheses, such as overconfidence or information advantage. Finally, we separately establish a link between optimism towards the home market and international portfolio diversification.

Is local bias a cross-border phenomenon? Evidence from individual investors’ international asset allocation

“…Our findings complement the research of Bailey et al (2008) and Graham et al (2009) who show that individuals make international investment decisions which are at least partly driven by behavioral heuristics capable of reducing or even erasing the benefits of international portfolio diversification. Moreover, Bartram et al (2012) only recently show that a stock's connectedness to foreign securities through common shareholders plays an important role in explaining cross-country return comovement beyond national borders and industries.…”

Cognitive abilities and portfolio choice

“…Bernheim and Garrett (2003) show that workers' saving choices are affected by the employer-based programs of financial education. Lusardi and Mitchell (2006) find a negative association between planning for retirement and financial education and Graham, Harvey, and Huang (2005) show that investors who claim to understand investment products hold more efficient portfolios. Van Rooij, Alessie and Lusardi (2007) find that in a Dutch household survey those who have low financial literacy are also less likely to invest in stocks.…”

Financial literacy, financial advice, and financial behavior

“…To overcome this data limitation, the author resorts to the imputation method proposed by Browning and Leth-Petersen (2003) and designed to link datasets featuring the above-mentioned properties. Following Graham et al (2009) and Korniotis and Kumar (2013), who apply this approach to infer individuals' perceived competence and smartness, respectively, the author proceeds in two steps to obtain a demographics-based financial literacy variable. First, he estimates an empirical model of financial literacy using the first wave of the PHF survey which contains both a direct measure of financial literacy and several of the demographic characteristics that have been shown to explain a significant proportion of the cross-sectional variation in people's financial literacy levels (see Sect.…”