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Financial Literacy and Home Bias in Household Investments

Using data from the RAND American Life Panel, I investigate differences in households’ investments in foreign assets with special emphasis on financial literacy. The results indicate that American households overweigh their portfolio with domestic assets and that financially literate households are more likely to invest as well as hold a greater fraction of their portfolio in foreign assets. When taking the selection into financial asset ownership into account, the positive relationship between financial knowledge and foreign asset ownership remains unchanged. Additionally, I exploit information about the education level of the respondents’ parents to remedy the potential problem of endogeneity of financial literacy. Interestingly, professional financial advice does not deplete the positive association between financial literacy and foreign asset holdings. Improving financial knowledge can, beyond increasing stock market participation, improve portfolio performance by reducing home bias and foster resilience of households’ retirement savings against country specific risks.