7. Motives and Reasons for Proximity Bias

This chapter presents and discusses the explanations for the proximity bias of investors based on the contemporary literature. The proximity bias of investors despite the well-documented gains from diversification still remains an unresolved empirical puzzle in the finance literature. Previous research offers a number of explanations for the proximity bias. In the international context, these explanations focus on, for instance, barriers to international investments such as foreign taxes, governmental restrictions on foreign and domestic investments, high transaction costs, exchange rate fluctuations, sovereign risk, cultural differences, language, hedging, and information asymmetry. In the domestic context, this strong preference might be explained by the information asymmetry, familiarity hypothesis, the passiveness of investors, or indisputable preference of investors. Our main focus is on the explanations for the domestic context.