Beyond home bias

Abstract

We investigate whether information frictions are important determinants of banks' sovereign debt portfolios. Going beyond the classic home versus foreign distinction in holdings, we study the heterogeneity within the foreign sovereign portfolio. First, we propose a modified version of the Van Nieuwerburgh and Veldkamp (2009) model with a two-tiered information structure that links portfolio holdings and information acquisition. Second, we find strong support for the key predictions of the model in the data: if a bank makes a forecast for a given country, it is more likely to hold debt of that country. Moreover, more optimistic and more precise forecasts predict larger portfolio holdings.