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«Oscar Stolper (University of Giessen) Andreas Walter (University of Giessen) Discussion Paper Series 1: Economic Studies No 23/2011 Discussion Papers ...»

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Home-field advantage

or a matter of ambiguity aversion?

Local bias among German individual investors

Markus Baltzer

(Deutsche Bundesbank)

Oscar Stolper

(University of Giessen)

Andreas Walter

(University of Giessen)

Discussion Paper

Series 1: Economic Studies

No 23/2011

Discussion Papers represent the authors’ personal opinions and do not necessarily reflect the views of the

Deutsche Bundesbank or its staff.

Editorial Board: Klaus Düllmann

Frank Heid

Heinz Herrmann Karl-Heinz Tödter Deutsche Bundesbank, Wilhelm-Epstein-Straße 14, 60431 Frankfurt am Main, Postfach 10 06 02, 60006 Frankfurt am Main Tel +49 69 9566-0 Telex within Germany 41227, telex from abroad 414431 Please address all orders in writing to: Deutsche Bundesbank, Press and Public Relations Division, at the above address or via fax +49 69 9566-3077 Internet http://www.bundesbank.de Reproduction permitted only if source is stated.

ISBN 978-3–86558–750–3 (Printversion) ISBN 978-3–86558–751–0 (Internetversion) Abstract We analyze the effect of geographic proximity on individual investors’ portfolio choice.

Using a unique data set which covers the common stockholdings of private households at regional banks in Germany, we document strong and consistent overinvestment in geographically close companies. Our results conclusively reject the presence of an informational advantage (‘home-field advantage’) of local over non-local investors. Instead, households’ preference for local equity turns out to be familiarity-driven. We conclude that individual investors’ local bias is induced by ambiguity aversion in the portfolio selection process rather than a trading strategy based on superior information about local companies.

Keywords: Local bias, portfolio diversification, household finance, investor behaviour, ambiguity aversion JEL-Classification: G01, G11, G14 Non-technical summary This paper investigates the role individual investors’ geographic location plays in their equity investment decisions. Even though classic theory postulates that utilitymaximizing investors greatly benefit from holding well-diversified portfolios of risky assets, evidence on real-life investment decisions paints a different picture. In particular, recent research suggests that investors not only eschew foreign shares (home bias puzzle), but―in addition to this―tilt their domestic stockholdings towards locally headquartered companies. This phenomenon of disproportionately overweighting nearby firms has been dubbed local bias in the literature and has proved robust across a variety of countries and for private and institutional investors alike.

Yet, while the presence of local bias among investors is undisputed by now, academics still struggle to explain its causes thoroughly. Why do investors tilt their portfolios towards local stocks? Given that local bias (a) constitutes one of retail investors’ most fundamental deviations from what textbook models claim about optimal asset allocation and (b) has been shown to be strong enough to move markets, finding answers to this question is relevant for several reasons.

Several contributions to the local bias literature suggest that households’ overweight in geographically close stocks reflects informed (i.e. rational) investment decisions which is based on an information advantage in evaluating nearby companies (information hypothesis).

Yet, empirical evidence on informational advantages as the trigger for investors’ local bias is mixed and a variety of studies indicate that local bias, quite on the contrary, is actually detrimental to investor welfare. If this is the case, understanding the root cause of local bias is particularly important since it provides the basis for reducing the welfare costs of this investment mistake. As such, a number of studies in the field soften or even reject the information hypothesis and instead advocate that local bias is the result of investors’ preference to invest in the familiar. However, due to the lack of a comprehensive analytical framework, these studies cannot explain exactly how investors’ familiarity with an asset actually affects local bias.

Following a theoretical concept by Boyle et al (2011), this paper investigates whether local bias can be explained when incorporating familiarity towards stocks (and issuing companies) as an additional dimension to the information-based portfolio selection process. Our research is based on the Security Deposits Statistics maintained by Deutsche Bundesbank which collects the common stockholdings of retail customers at German regional banks on a security-by-security basis and allows specifying the geographical proximity between investor and company headquarters.

We find that, indeed, private households in Germany significantly overweight nearby stocks and show that this result is robust across a number of different breakdowns.

Second, we investigate whether the observed portfolio locality is informationdriven―i.e. generates positive alpha―and conclusively reject the notion of a ‘homefield advantage’ for German individual investors. Finally, we test key propositions of the framework of investor familiarity developed by Boyle et al. (2011). Our data clearly confirms their hypotheses with regard to overinvestment in the familiar and empirically support a flight to familiarity during financial crises. In sum, our results suggest that including investors’ ambiguity aversion towards the available assets in the asset allocation problem contributes to explaining local bias among individual investors.





Nichttechnische Zusammenfassung In dieser Studie untersuchen wir die Bedeutung des eigenen Standorts für die Anlageentscheidungen privater Aktieninvestoren. Obwohl die klassische Portfoliotheorie besagt, dass ein Nutzen maximierender Investor in hohem Maße von einem gut diversifizierten Portfolio riskanter Wertpapiere profitiert, zeigt sich bei der Untersuchung tatsächlich getätigter Investitionen ein anderes Bild. So offenbaren neuere Studien, dass in den Depots privater Anleger nicht nur ausländische Aktien unterrepräsentiert sind (home bias), sondern diese darüber hinaus auch bei ihren inländischen Aktieninvestments solche Unternehmen übergewichten, die sich im unmittelbaren Umkreis ihres Wohnorts befinden. Dieses Phänomen der Übergewichtung lokal ansässiger Unternehmen im Portfolio inländischer Aktienanlagen wird in der Literatur als local bias bezeichnet und konnte empirisch für eine Vielzahl von Ländern sowie für sowohl private als auch institutionelle Investoren nachgewiesen werden. Während das Vorliegen eines solchen local bias in der Literatur mittlerweile unbestritten ist, stellt sich weiterhin die Frage nach einer umfassenden Erklärung für diese Verhaltensanomalie.

Einige Beiträge zur einschlägigen Literatur sehen in der Übergewichtung lokaler Aktien informierte (d.h. rationale) Anlageentscheidungen. Sie gehen von einem Informationsvorsprung bei der Bewertung lokaler Aktieninvestments aus. Allerdings ist die empirische Evidenz für Informationsvorteile als Ursache des local bias nicht eindeutig. So zeigt eine Vielzahl anderer Studien, dass sich Anleger durch die Übergewichtung lokaler Unternehmen systematisch schlechter stellen. Dieser zweite Literaturstrang stellt die Informationshypothese in Frage und argumentiert, dass der local bias letztlich auf eine Präferenz des Anlegers zurückzuführen ist, in das Bekannte und Vertraute zu investieren. Aufgrund eines fehlenden umfassenden analytischen Rahmens konnten diese Studien bislang allerdings nicht klären, inwiefern die Vertrautheit eines Investors mit einer Anlage den zu beobachtenden local bias beeinflusst.

Aufbauend auf einem theoretischen Konzept von Boyle et al. (2011) berücksichtigt die vorliegende Studie neben dem informationsbasierten Ansatz auch die Vertrautheit des Anlegers mit der fraglichen Aktie (bzw. dem zugrundliegenden Unternehmen) zur Erklärung des local bias. Unsere Untersuchung basiert auf der Depotstatistik der Deutschen Bundesbank, die die Aktienbestände von Privatanlegern bei deutschen Regionalbanken erhebt und es erlaubt, die räumliche Nähe zwischen Anleger und dem Sitz der Aktienunternehmen zu spezifizieren.

Unsere Ergebnisse belegen, dass deutsche Privathaushalte lokal ansässige Unternehmen systematisch und deutlich übergewichten. Eine umfassende Analyse der mit den Aktien lokaler bzw. räumlich entfernter Unternehmen erwirtschafteten Renditen zeigt außerdem, dass die These eines „Heimvorteils“ für lokale Anleger verworfen werden muss (Informationshypothese). Schließlich prüfen wir einige der zentralen Thesen des von Boyle et al. (2011) entwickelten Modells zur Rolle von Vertrautheit für Investoren.

Hier bestätigen unsere Ergebisse deren Hypothesen, dass Privatanleger einerseits vertraute Wertpapiere übergewichten und dass sich andererseits in Krisenphasen ein flight to familiarity―also eine noch stärker ausgeprägte Übergewichtung in vertraute Aktien―beobachten lässt.

Zusammenfassend legen unsere Ergebnisse damit nahe, dass die Berücksichtigung einer Vertrautheitskomponente bei der Aktienportfoliozusammensetzung einen entscheidenden Beitrag zur Erklärung des local bias bei Privatanlegern leistet.

Contents 1 Introduction and related research

2 Data and descriptive statistics

2.1 Data

2.2 Descriptive statistics

3 Do German individual investors exhibit a local equity preference?

3.1 Assessing the locality of investors’ stockholdings

3.2 Results

4 Testing the information hypothesis: Do German individual investors yield excess returns on their local stock investments?

4.1 General intuition

4.2 Methodology

4.3 Results

5 Testing the familiarity hypothesis: Investor ambiguity aversion and local bias..... 19

5.1 General intuition

5.2 Methodology

5.3 Results

6 Conclusion

List of Figures Figure 1: Geographical distribution of German individual investors and public limited companies

Figure 2: Changes in local bias among German individual investors during the sample period

Figure 3: Local bias of German individual investors under changing market conditions

List of Tables

Table 1: Summary statistics of sampled investor portfolios, custodian banks, and companies

Table 2: Locality of German individual investors’ stockholdings

Table 3: Locality of German individual investors’ stockholdings, by investor location and index status

Table 4: Portfolio performance of German individual investors’ stockholdings (Holdings-based portfolios, 3-month returns)

Table 5: Portfolio performance for investor quartiles formed on local bias levels (Holdings-based portfolios, 3-month returns)

Table 6: Portfolio performance of German individual investors’ stockholdings (Transactions-based portfolios, 12-month returns)

Table 7: Impact of changes in stock market uncertainty on change in local bias levels among German individual investors

Table 8: Market performance and local bias among German individual investors..... 40 Table 9: Variation in local bias changes across German individual investors............. 41 Home-field advantage or a matter of ambiguity aversion?

Local bias among German individual investors∗

1 Introduction and related research

This paper investigates the role individual investors’ geographic location plays in their equity investment decisions. Even though classic theory postulates that utility-maximizing investors greatly benefit from holding well-diversified portfolios of risky assets, evidence on real-life investment decisions paints a quite different picture. In particular, recent research suggests that investors not only eschew foreign shares1, but―in addition to this―tilt their domestic stockholdings towards locally headquartered companies. This phenomenon of disproportionately overweighting nearby firms has been dubbed local bias in the literature and has proved robust across a variety of countries and for private and institutional investors alike.2 Yet, while the presence of local bias among investors is undisputed by now, academics still struggle to explain its causes thoroughly. Why do investors tilt their portfolios towards local stocks? Finding answers to this question is relevant for several reasons.



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