Abstract

Heuristic Approaches to Availability, Competence Effects and Return Expectations in Respect of Defence-Industry Shares during the Iraqi War

Overall, the structures of private-investor depots show substantial diversification deficits so that - within the meaning of the portfolio theory - exclusively inefficient risk/return combinations have been realised. Whilst - for purposes of international diversification - such deficits have been referred to as "home bias" and been rather intensively analysed already, the knowledge of the kind of domestic shares included in private-investor portfolios and of the reasons pertaining to the choice of such shares has been rather poor so far. The thesis that "familiarity breeds investment" is known from the field of behavioural finance. This thesis suggests that investors mainly choose shares for which information is readily available to them and/or shares of companies domiciled in the regions in which they live.

This explanation may seem to be intuitively plausible, but it fails to show any connection with the portfolio theory. This is the point where our analysis starts, arguing that availability of information results in a stronger competence feeling and that the so perceived competence translates into systematically distorted estimations of the yield spread parameters of shares. The present analysis examines this competence effect for German and US defence-industry shares. In December 2000 and March 2003 private investors and young officers of the German armed forces (Bundeswehr) were asked about their individual return expectations for such shares.

The main results of this study are that the reasons derived from behavioural finance to explain the competence effect are relevant in various respects also in this case. However, it has turned out that officers familiar with defence goods do not feel to be more competent for evaluating defence-industry shares.