Fear of the Unknown: Familiarity and Economic Decisions

By H. Cao, Bing Han, David A. Hirshleifer, Harold H. Zhang, Lorenzo Garlappi, Mark J. Garmaise, Simon Gervais, John S. Griffin, Danling Jiang, Chester Spatt and 2 more. 2007

199 citations recorded by the source corpus.

Evidence indicates that people fear change and the unknown. We offer a model of familiarity bias in which individuals focus on adverse scenarios in evaluating defections from the status quo. The model explains the endowment effect, portfolio underdiversification, home and local biases. Equilibrium stock prices reflect an unfamiliarity premium. In an international setting, our model implies that the absolute pricing error of the standard CAPM is positively correlated with the amount of home bias. It also predicts that a modified CAPM holds wherein the market portfolio is replaced with a portfolio of the stock holdings of investors not subject to familiarity bias.

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/75989e3ce505d0d605366c14396b74f3bcbe09c8

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Citations in the corpus

US presidential elections and implied volatility: The role of political uncertainty (2013, unknown): “Cao et al. (2011) suggest that pessimistic beliefs are engendered by contemplation of actions that deviate from the status quo.”
A Sparsity-Based Model of Bounded Rationality (2014, unknown): “Cao et al. (2011) obtain a related prediction in a Gilboa and Schmeidler (1989) type of setting, and propose that it helps understand a variety of behavioral finance phenomena.”
Ambiguity and Asset Markets (2010, background): “Cao et al. (2007) summarize the evidence and discuss ambiguity aversion as a possible interpretation.”