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Institute for Financial Research SIFR Research Report Series, Institute for Financial Research

No 21:
Hedging, Familiarity and Portfolio Choice

Massimo Massa () and Andrei Simonov

Abstract: We exploit the restrictions of intertemporal portfolio choice in the presence of non-financial income risk to design and implement tests of hedging that use the information contained in the actual portfolio of the investor. We use a unique dataset of Swedish investors with information broken down at the investor level and into various components of wealth, investor income, tax positions and investor demographic characteristics. Portfolio holdings are identified at the stock level. We show that investors do not engage in hedging, but invest in stocks closely related to their non-financial income. We explain this with familiarity, that is the tendency to concentrate holdings in stocks with which the investor is familiar in terms of geographical of professional proximity or that he has held for a long period. We show that familiarity is not a behavioral bias, but is information-driven. Familiarity-based investment allows investors to earn higher returns than they would have otherwise earned if they had hedged.

Keywords: Asset pricing; Portfolio decision; Hedging; (follow links to similar papers)

JEL-Codes: G11; G14; (follow links to similar papers)

70 pages, March 15, 2004

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