Many papers have argued that home bias arises because home investors can predict payoffs of their home assets more accurately than foreigners can. But why does this information advantage exist in a world where investors can learn foreign information? We model investors who are endowed with a small home information advantage. They can choose what information to learn before they invest in many risky assets. Surprisingly, even when home investors can learn what foreigners know, they choose not to. The reason is that investors profit more from knowing information that others do not know. Allowing investors to learn amplifies their initial information asymmetry. The model explains local and industry bias as well as observed patterns of foreign investments, portfolio out-performance and asset prices. Finally, we outline new avenues for empirical research.

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We develop a model of the gambler’s fallacy–the mistaken belief that random sequences should exhibit systematic reversals. We show that an individual who holds this belief and observes a sequence of signals can exaggerate the magnitude of changes in an underlying state but underestimate their duration. When the state is constant, and so signals are i.i.d., the individual can predict that long streaks of similar signals will continue–a hot-hand fallacy. When signals are serially correlated, the individual typically under-reacts to short streaks, over-reacts to longer ones, and under-reacts to very long ones. Our model has implications for a number of puzzles in Finance, e.g., the active-fund and fund-flow puzzles, and the presence of momentum and reversal in asset returns.

Using the historical random assignment of MBA students to sections at Harvard Business School, I show that executive peer networks are important determinants of managerial decisionmaking and firm policies. Within a class, executive compensation and acquisitions strategy are significantly more similar among graduates from the same section than graduates from different sections. Both executive compensation and acquisitions propensities have elasticities of 10-20% with respect to the mean characteristics of section peers. I demonstrate the important role of ongoing social interactions by showing that peer effects are more than twice as strong in the year immediately following staggered alumni reunions. I further show that peer effects in compensation are not driven by similarities in underlying managerial productivity using a test of "pay for friend’s luck": pay responds to lucky industry-level shocks to the compensation of peers in distant industries. Finally, I show that social interactions increased the between-section variance in outcomes by 20-40%, demonstrating that peer effects can significantly contribute to the large variation in outcomes across peer groups.

Abstract Modern …nancial systems exhibit a high degree of interdependence. There are different possible sources of connections between …nancial institutions, stemming from both the asset and the liability side of their balance sheet. For instance, banks are directly connected through mutual exposures acquired on the interbank market. Likewise, holding similar portfolios or sharing the same mass of depositors creates indirect linkages between …nancial institutions. Broadly understood as a collection of nodes and links between nodes, networks can be a useful representation of …nancial systems. By providing means to model the speci…cs of economic interactions, network analysis can better explain certain economic phenomena. In this paper we argue that the use of network theories can enrich our understanding of …nancial systems. We review the recent developments in …nancial networks, highlighting the synergies created from applying network theory to answer …nancial questions. Further, we propose several directions of research. First, we consider the issue of systemic risk. In this context, two questions arise: how resilient …nancial networks are to contagion, and how …nan-cial institutions form connections when exposed to the risk of contagion. The second issue we consider is how network theory can be used to explain freezes in the interbank market of the type we have observed in August 2007 and subsequently. The third issue is how social networks can improve investment decisions and corporate governance. Recent empirical work has provided some interesting results in this regard. The fourth issue concerns the role of networks in distributing primary issues of securities as, for example, in initial public o¤erings, or seasoned debt and equity issues. Finally, we consider the role of networks as a form of mutual monitoring as in micro…nance.

particularly thank Paul Kaplan (for providing manager data) and Lorene Kennard (for providing help in finding missing manager data) at Morningstar, Robin Thurston and Lucas Garland (for providing fund director data) at Lipper, Thomson Wiesenberger (for providing manager data), and the Center for Institutional Investment Management at the School of Business of SUNY at Albany (for providing Morningstar On-Disc and Principia CDs). Part of this work was completed while Ding was at Wharton Research Data Services (WRDS). Wermers gratefully acknowledges financial support from the Division

We investigate whether outside board memberships of CEOs signal expertise or entrenchment. The analysis is based on panel data of the largest German companies covering the period from 1996 to 2008. Supporting the entrenchment hypothesis, our analysis reveals that firms having a CEO with one or more outside mandates suffer from significantly weaker firm performance compared with firms having a CEO without any outside board mandates. Moreover, disciplinary CEO turnovers become less likely and turnover-performance sensitivity declines with rising board memberships of the top manager. We conclude that outside mandates enhance managerial power at the expense of the home firm's shareholders. JEL-Classification: J24, J63, L25, M50

An important question in the entrepreneurship literature is whether peers affect the decision to become an entrepreneur. We exploit the fact that Harvard Business School assigns students into sections, which have varying representation of former entrepreneurs. We find that the presence of entrepreneurial peers strongly predicts subsequent entrepreneurship rates of students who did not have an entrepreneurial background, but in a more complex way than the literature has previously suggested. A higher share of students with an entrepreneurial background in a given section leads to their peers to lower rather than higher subsequent rates of entrepreneurship. However, the decrease in entrepreneurship is entirely driven by a reduction in unsuccessful entrepreneurial ventures. The relationship between the shares of pre-HBS and successful post-HBS peer entrepreneurs is insignificantly positive. In addition, sections with few prior entrepreneurs have similar enrollment rates in elective entrepreneurship classes and a considerably higher variance in their rates of unsuccessful entrepreneurs. We argue that these results are consistent with intra-section learning, where the close ties between section-mates lead to insights about the merits of business plans. We would like to thank a number of Harvard Business School officials and faculty who made

Mutual funds change their risk levels significantly over time. Risk shifting might be caused by ill-motivated trades of unskilled or agency-prone fund managers who trade to increase their personal compensation. Alternatively, risk shifting might occur when skilled fund managers trade to take advantage of their stock selection and timing abilities. This paper investigates the performance consequences of risk shifting and sheds light on the mechanisms and the economic motivations behind the risk shifting behavior. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time, suggesting that risk shifting is either an indication of inferior ability or is motivated by agency issues.

We study the impact of social networks on agents’ ability to gather superior information about firms. Exploiting novel data on the educational backgrounds of sell side equity analysts and senior officers of firms, we test the hypothesis that analysts’ school ties to senior officers impart comparative information advantages in the production of analyst research. We find evidence that analysts outperform on their stock recommendations when they have an educational link to the company. A simple portfolio strategy of going long the buy recommendations with school ties and going short buy recommendations without ties earns returns of 6.60 % per year. We test whether Regulation FD, targeted at impeding selective disclosure, constrained the use of direct access to senior management. We find a large effect: pre-Reg FD the return premium from school ties was 9.36 % per year, while post-Reg FD the return premium is nearly zero and insignificant. In contrast, in an environment that did not change selective disclosure regulation (the UK), the analyst school-tie premium has remained large and significant over the entire sample period.