Portfolio Choice: Familiarity, Hedging, and Industry Bias

Abstract

Investors may under-diversify their portfolios by overweighting securities in which they perceive an informational advantage or by underweighting securities to hedge risks outside the portfolio. We investigate under-diversification in institutional portfolio construction by examining the under/overweighting of industries in U.S. Property-Liability (PL) insurers’ equity portfolios. We find that PL insurers underweight their own industry in their portfolios, as well as highly correlated industries. This underweighting is larger for PL insurers exposed to higher underwriting risk. While PL insurers have an informational advantage in investing in their peers, their underwriting risk drives them to underweight stocks in their industry.

Keywords: Familiarity; Hedging; Industry Bias; Under-Diversification

JEL Classification: G11, G02