Do you prefer to bet on the decrease of the Dow Jones or the CAC40 on the first of next September?
These questions have been asked in many economic experiments to MBA students and financial professionals in France and in the US.
Without surprises, most Americans prefer to bet on the Dow Jones and most French investors prefer to bet on the CAC40.
The issue is that if the question is now: “Do you prefer to bet on the increase of the Dow Jones or the CAC40 on the first of next September?
The answers of investor will be the same. Most Americans prefer to bet on the Dow Jones and most French investors prefer to bet on the CAC40.
Home bias is a cognitive bias that makes us prefer to invest in something we know, even if it is not the most optimal investment to make.
This bias has been particularly studied for its impact on financial markets and its mechanisms are still not very well understood.
It highly affects retail investors too, who prefer to invest in sectors they are comfortable with or easy to understand such as real estate or gold, even if these investments are not always optimal.
Prospect Theory, for risk and ambiguity, Wakker (2011)
Coeurdacier, N., & Gourinchas, P. O. (2011). When bonds matter: home bias in goods and assets (No. w17560). National Bureau of Economic Research.
Abdellaoui, M., Baillon, A., Placido, L., & Wakker, P. (2009). The rich domain of uncertainty. American Economic Review.Psychology of investing, John Nofsinger, 2004
Coval, J. D., & Moskowitz, T. J. (1999). Home bias at home: Local equity preference in domestic portfolios. The Journal of Finance, 54(6), 2045-2073.