We now describe some of the evidence on the actions of investors and the
behavioral ideas that have been used to explain it.
7.1. Insufficient DiversificationA large body of evidence suggests that investors diversify their portfolio
holdings much less than is recommended by normative models of portfolio
choice.
First, investors exhibit a pronounced “home bias.” French and Poterba
(1991) report that investors in the United States, Japan, and the United
Kingdom allocate 94 percent, 98 percent, and 82 percent of their overall
equity investment, respectively, to domesticequities. It has not been easy to
explain this fact on rational grounds (Lewis 1999). Indeed, normative port-
folio choice models that take human capital into account typically advise
investors to shorttheir national stock market, because of its high correla-
tion with their human capital (Baxter and Jermann 1997).
Some studies have found an analog to home bias within countries. Using
an especially detailed data set from Finland, Grinblatt, and Keloharju
(2001) find that investors in that country are much more likely to hold and
trade stocks of Finnish firms which are located close to them geographi-
cally, which use their native tongue in company reports, and whose chief
executive shares their cultural background. Huberman (2001) studies the
geographic distribution of shareholders of U.S. Regional Bell Operating
Companies (RBOCs) and finds that investors are much more likely to hold
shares in their local RBOC than in out-of-state RBOCs. Finally, studies of
allocation decisions in 401(k) plans find a strong bias towards holding own
company stock: over 30 percent of defined contribution plan assets in large
U.S. companies are invested in employer stock, much of this representing
voluntary contributions by employees (Benartzi 2001).
In section 3, we discussed evidence showing that people dislike ambigu-
ous situations, where they feel unable to specify a gamble’s probability dis-
tribution. Often, these are situations where they feel that they have little
competence in evaluating a certain gamble. On the other hand, people
show an excessive liking for familiar situations, where they feel they are in
a better position than others to evaluate a gamble.
Ambiguity and familiarity offer a simple way of understanding the differ-
ent examples of insufficient diversification. Investors may find their na-
tional stock markets more familiar—or less ambiguous—than foreign stock
indices; they may find firms situated close to them geographically more fa-
miliar than those located further away; and they may find their employer’s
stock more familiar than other stocks.^34 Since familiar assets are attractive,
A SURVEY OF BEHAVIORAL FINANCE 51(^34) Particularly relevant to this last point is survey data showing that people consider their
own company stock less risky than a diversified index (Driscoll et al. 1995).