Individual investors tend to invest in stocks that are headquartered close to their home, a pattern called ‘home bias’. Indeed, investors disproportionately invest in local assets (national or regional bonds or stock), holding an undiversified portfolio and consequently concentrating risks rather than spreading them out.
Worse yet, many workers would invest in their own company stocks, exposing them to a dangerous scenario of losing both labor income and stock market wealth if their company suffers any financial distress. It is a common scenario that the employees own the employers’ stocks in their retirement accounts.
The psychological mechanisms that generate the home bias are not precisely known. Several likely mechanisms might be implied:
- an aversion to ambiguity (called also uncertainty aversion). The investor would prefer known risks over unknown risks
- preference for familiar “items”
- and a desire to ‘keep up with the neighbors” (keeping up with the Joneses)…..emulating the investments of your neighbors
- Foreign currency exchange risk: Investing in foreign equities necessarily involves foreign currency exchange risk. (But this currency diversification could be rather a benefit in some extent)