Portfolio choice, behavioral preferences and equity home bias

We provide a plausible explanation of aggregate portfolio behavior, in a framework where economic agents have behavioral (narrow framing) preferences. The representative agent derives utility not only from consumption (standard models) but also from risky financial wealth fluctuations. Moreover, the investor frames the stock market risk narrowly and has loss averse preferences. We numerically solve, for the foreign equity share, a simple model of international portfolio choice, providing a possible explanation for the equity home bias puzzle. Only economic agents able to process correctly information deriving from stock markets exploit the diversification opportunities provided by international financial markets.