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RFS Advance Access originally published online on January 19, 2006
Review of Financial Studies 2006 19(2):633-685; doi:10.1093/rfs/hhj013
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Hedging, Familiarity and Portfolio Choice

Massimo Massa
INSEAD

Andrei Simonov
Stockholm School of Economics

Address correspondence to M. Massa, Finance Department, INSEAD, Boulevard de Constance, 77305 Fontainebleau Cedex, France, or email: massimo.massa{at}insead.edu.

We exploit the restrictions of intertemporal portfolio choice in the presence of nonfinancial income risk to test hedging using the information contained in the actual portfolio of the investor. We use a unique data set of Swedish investors with information broken down at the investor level and into various components of investor wealth, income, and demographic characteristics. Portfolio holdings are identified at the stock level. We show that investors do not hedge but invest in stocks closely related to their nonfinancial income. We explain this with familiarity, that is, the tendency to concentrate holdings in stocks to which the investor is geographically or professionally close or that he has held for a long period. We show that familiarity is not a behavioral bias, but is information driven. Familiarity-based investment allows investors to earn higher returns than they would have otherwise earned if they had hedged.


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