Familiarity bias investigation in portfolio creation

Abstract

The prevailing opinion exists that investors include to their portfolio what they know or what is located around them. Investment decision, which is impacted by familiarity bias, avoid including international companies to portfolio which might lead to lower performance compared to portfolio which has both, local and international, stocks in a portfolio. The aim of this study is to analyse the impact of familiarity bias on investment decision, to form portfolios from the stocks listed on the Nasdaq Baltic stock exchange and compare their performance to global portfolios, which are formed from the stocks listed on the New York Stock Exchange. Investment portfolios were built using mean variance (MV) and Black–Litterman (BL) models. The analysis revealed that the returns of the portfolios built on the Nasdaq Baltic exchange are higher than the returns of the global portfolios. Additionally, the volatility of returns is lower for Nasdaq Baltic portfolios. When selected markets have different growth rates, investment decisions based on familiarity bias can achieve better results.