INSIDE INFORMATION AND THE OWN COMPANY STOCK PUZZLE

U.S. investors allocate 30–40% of their financial asset portfolio in the stock of the company they work for. Such a portfolio flies in the face of standard portfolio theory, which prescribes that an investor should hold less of a financial asset that is positively correlated with her undiversified labor income. Nevertheless, we propose a rational explanation that prescribes a long position in own company stock. Precisely because the own company stock is positively correlated with the investor's labor income, any information the investor learns about her earnings is a partial information advantage in her own company stock. When confronted with a choice of what information to acquire, employees may choose to learn about their own firm. Learning lowers the employee's risk of holding own‐firm equity, which raises its risk‐adjusted returns and makes a long position optimal. (JEL: F30, G11, D82)