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feng_seasholes_homebias_20040120

feng_seasholes_homebias_20040120 - Location Eects and...

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Location Effects and Portfolio Tilting Lei Feng McKinsey & Co. Mark S. Seasholes U.C. Berkeley This Version January 2004 * Abstract We show individuals tilt their portfolios towards stocks based on geographic location (where the investor currently lives, where the investor was born, where the company is headquartered, and where the stock is listed). Surprisingly, stocks that are traded near where an investor lives receive the highest weights in the investor’s portfolio—a result that offers a startling re-interpretation of the existing home bias literature. We believe this is the first paper to establish a clientele effect based on location of trade. Data are consistent with a framework in which the investor faces a costly search process when choosing which stock to buy. These costs are shown to have long-lived effects. Our research exploits unique features of an emerging stock market that allow us to decompose holdings into orthogonal, location-based dimensions. Results are robust to numerous econometric specifications. Keywords: Individual Investors, Behavioral Finance, Home Bias JEL number: G15, F3, D1 * We thank James Guo, Terry Hendershott, Chris Hennessy, Jacob Sagi, Armin Schweinbacher. We also thank members of the finance departments at Berkeley, Duke, and HKUST, the research department at B.G.I., as well as the PBFA Conference. Thuy-Uyen Dam provided some excellent research support. Any mistakes are ours alone. Contact information: Mark S. Seasholes, U.C. Berkeley Haas School of Business, 545 Student Services Bldg., Berkeley CA 94720; Tel: 510-642-3421; Fax: 510-643-1420; email: [email protected] c 2004. 1
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1 Introduction Do investors tilt their portfolios towards certain types of stocks? This seemingly simple ques- tion has generated, and continues to generate, a large amount of debate among economists. A search for the term “home bias” on EconLit, JSTOR, and SSRN yields over 200 citations. The majority of these papers were written within the last five years. If investors are tilting their portfolios, what can we learn about portfolio choice? What can we learn about markets? Are there barriers to investment, large frictions, or hidden transaction costs? Are portfolio choices linked to the structure of information and the ability to process it? More generally, economists want to know if there is a “rational” explanation for tilting one’s portfolio (such as transaction costs, hedging demands, information asymmetry, etc.), or if the behavior is driven by psychological biases. This paper undertakes a systematic study of investor holdings in an attempt to answer the questions above. To begin, we introduce a framework for thinking about individual portfolio choice. The framework is based on Weitzman’s (1979) search model. Data are consistent with investors facing a costly search when choosing stocks. After we propose a rough classification system for the ways an investor might tilt (bias) his or her portfolio, we turn to empirical analysis. We exploit the unique market structure in the People’s Republic of China (PRC) in order to carry out tests that were not previously possible. The PRC is
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