Beyond Home Bias: Portfolio Holdings and Information Heterogeneity

We study whether information frictions are important determinants of banks’ interna- tional portfolio holdings. Going beyond the classic distinction of home versus foreign assets, we focus on the heterogeneity within foreign holdings. First, we document that banks invest only in a few foreign countries, even when considering a class of assets that is highly homogeneous across destination countries (European sovereign bonds). Large, global banks have portfolios that are more diversified than small banks but they still overweight domestic assets relative to foreign. Second, we propose a new model with a two-tiered information cost structure – including both a fixed and a variable component – that can rationalize these facts. Finally, we test the key predictions of the model in the data. We find that more precise information leads to larger holdings, and also amplifies the effect of expected returns on portfolio holdings.