Familiarity and surprises in international financial markets

An increasing number of papers in finance and international finance have documented the relationship between attention allocation and portfolio choice problems. While both literatures are documenting similar phenomena, different dimensions of attention are driving each result. In international finance, emphasis on geography suggests that familiarity-induced attention is the main channel being explored. In finance, however, results appear to be capturing the effect of surprise-induced attention caused by abnormal trading volume or extreme one-day returns.

In this paper, we bridge both literatures together by presenting a methodology which formally disentangles the influence of familiarity and surprises on attention and the implications of each component for asset allocation choices. We find that familiarity-induced attention leads to an increase in US holdings of foreign equities. On the other hand, surprise-induced attention is associated with net selling of foreign stocks because US investors tend to pay more attention to negative than to positive economic surprises from other countries. Our findings suggest that information asymmetries between locals and non-locals are more pronounced when it comes to good news, with information regarding bad news being relatively symmetric.