The hometown bias puzzle in investing

In its chapters on investing, Nudge puzzles over the “home bias puzzle,” in which investors in a given country tend to overweight their portfolios with stocks from that country. So for instance, although U.S. equities make up less than half of the global stock market, most U.S. investors’ portfolios are dominated by them. This kind of geographical proximity in investing is often explained by differences in regulation, culture, and taxation between nations, as well as differences in understanding about home versus foreign companies. These frictions can occur within nations as well, according to Tobias Moscowitz (of Chicago’s Booth School of Business) and Joshua D. Coval, leading to what might be called the “hometown bias puzzle.”

Using a unique database of mutual fund managers and company locations, identified by latitude and longitude, we find that the average U.S. fund manager invests in companies that are between 160 to 184 kilometers, or 9 to 11 percent, closer to her than the average firm she could have held. Alternatively, one out of every ten companies in a fund manager’s portfolio is chosen because it is located in the same city as the manager. With a variety of measures used, the null hypothesis of no local equity preference (or local bias) is consistently rejected, demonstrating that the distance between investors and potential investments is a key determinant of U.S. investment manager portfolio choice.

Why the hometown bias? Familiarity and understanding.

We find that local equity preference is strongly related to three firm characteristics: firm size, leverage, and output tradability. Specifically, locally held firms tend to be small, highly-levered, and produce goods not traded internationally. These results suggest an information-based explanation for local equity preference, since small, highly levered firms, whose products are primarily consumed locally, are exactly those firms where one would expect local investors to have easier access to information and are firms in which such information would be most valuable.

A pdf of the working paper is here.

Optimism in moderation

The Boston Globe writes about optimism research, and includes the following cautionary nugget about the virtues of moderate optimism.

Economists at Duke found that compared to pessimists, optimists work more hours per week, save more money, are more likely to own stock, and are more likely to say that they’re never going to retire…”The moderate optimists are prudent people,” said David Robinson, who conducted the Duke study. “They pay their credit cards on time. They tell you that they save because saving is a good thing to do. . . . Extreme optimists are just the opposite. They have short planning horizons, they don’t pay their credit cards off on time. As you get extremely optimistic, the good behaviors drop off.”

And this nugget about when optimism is beneficial and harmful.

The importance of positivity can vary by profession. University of Pennsylvania psychologist Martin Seligman, a leading researcher on optimism, has found that pessimistic law students are the most successful. Optimistic sales agents, on the other hand, significantly outsell pessimistic ones.

Are you an optimist? Take this quiz to find out.

Deliberation failures

Cass Sunstein and Reid Hastie of the University of Chicago Graduate School of Business have a new working paper titled “Four Failures of Deliberating Groups.” Here is the abstract:

Many groups make their decisions through some process of deliberation, usually with the belief that deliberation will improve judgments and predictions. But deliberating groups often fail, in the sense that they make judgments that are false or that fail to take advantage of the information that their members have. There are four such failures.

(1) Sometimes the predeliberation errors of group members are amplified, not merely propagated, as a result of deliberation.

(2) Groups may fall victim to cascade effects, as the judgments of initial speakers or actors are followed by their successors, who do not disclose what they know. Nondisclosure, on the part of those successors, may be a product of either informational or reputational cascades.

(3) As a result of group polarization, groups often end up in a more extreme position in line with their predeliberation tendencies. Sometimes group polarization leads in desirable directions, but there is no assurance to this effect.

(4) In deliberating groups, shared information often dominates or crowds out unshared information, ensuring that groups do not learn what their members know.

All four errors can be explained by reference to informational signals, reputational pressure, or both. A disturbing result is that many deliberating groups do not improve on, and sometimes do worse than, the predeliberation judgments of their average or median member.