In a time of tremendous advances in technology, it seems striking why the location of corporate headquarters should matter for the firm’s stock return. At first glance, low information and communication costs are thought to facilitate the interaction between market participants all around the world and, thus, deem the role of geographical loca-tion as marginal. This reasoning, however, does not take investors’ behavior into ac-count.
Even if over the past decades, international capital markets have widely been liberalized and the variety of investment opportunities across countries has grown substantially, many investors do not take the risk reduction potential of foreign assets into considera-tion. Despite the extensive benefits of international diversification, investors still over-weight domestic and local assets in their portfolios. Although this home bias has drawn much academic attention and its existence is commonly accepted, a satisfactory ration-ale could not yet be obtained. Further, the resulting economic implications for asset pricing remain unexplored. Yet, locality could be highly relevant for cost of capital cal-culation, asset allocation and performance evaluation.1
As a result, it is of crucial importance to investigate the relationship between portfolio holdings of investors and stock pricing patterns to shed light on a potential geographical component of asset pricing. The lack of academic research motivates to explore this area in greater detail. The purpose of this thesis is to fill the existing gap and establish a link between local bias and asset pricing. Therefore, a detailed overview of the home bias puzzle as well as of local asset pricing is presented. The economic impact of local bias on stock returns is empirically investigated. Thus, the key question of the analysis is whether the location of corporate headquarters has an impact on stock returns attributable to the local bias of investors.
Table of Contents
1 Introduction
1.1 Motivation and Problem Definition
1.2 Course of the Analysis
2 The Fundamentals of International Capital Markets
2.1 The Concept of Portfolio Theory
2.1.1 Portfolio Optimization
2.1.2 International Diversification
2.2 Integration versus Segmentation of Capital Markets
2.3 The Concept of Market Efficiency
2.3.1 Operational and Informational Market Efficiency
2.3.2 Market Efficiency and Behavioral Finance
3 Home Bias and Local Bias in Equities
3.1 Definition of Home Bias and Local Bias
3.2 Different Explanations to the Bias Puzzle
3.2.1 National Barriers to International Investments
3.2.2 Hedging of Country-specific Risks
3.2.3 Information Advantages of Local Investors
3.2.4 Familiarity
3.2.5 Social Interaction of Investors and Trading Patterns
3.3 Home Bias from a German Perspective
3.3.1 Benefits from International Diversification for German Investors
3.3.2 Actual Portfolio Holdings of German Investors
4 Geographic Component of Asset Pricing
4.1 Location of Corporate Headquarters
4.2 Agglomeration of Headquarters
4.3 Geographic Implications on Stock Returns
4.3.1 Fundamentals and Geographic Segmentation
4.3.2 Hypothesis of Local Asset Pricing
5 Description of the Data Set
5.1 Data Selection
5.2 Descriptive Statistics
6 Empirical Analysis
6.1 Comovement of Local Stocks
6.1.1 Methodology – Time-series Regressions
6.1.2 Results
6.2 Robustness Test
6.2.1 Resampling Method
6.2.2 Local Comovement versus Non-local Comovement
6.3 Local Comovement Attributable to Fundamentals
6.3.1 Methodology – Time-series Regressions
6.3.2 Results
6.4 Firm-specific and Regional Determinants
6.4.1 Methodology – Cross-sectional and Panel Regressions
6.4.2 Results
6.5 Limitations of the Model
7 Summary and Conclusion
Objectives and Research Focus
This thesis explores the relationship between the geographical location of corporate headquarters and stock returns. It investigates whether investors' local bias, characterized by the preference for geographically proximate assets, leads to a significant geographical component in asset pricing that cannot be solely attributed to market fundamentals.
- The influence of corporate headquarters' location on stock performance.
- Empirical analysis of local comovement of stock returns in Germany.
- Evaluation of whether local comovement is driven by rational fundamentals or geographical segmentation.
- Examination of firm-specific and regional determinants of local comovement.
Excerpt from the Book
3.1 Definition of Home Bias and Local Bias
Despite the commonly accepted gains from international diversification, the portfolios of investors are often biased towards their home country. The preference for domestic assets, also known as domestic bias, infers the existence of other determinants in investors’ asset allocation decision than standard portfolio theory predicts. This observation is not limited to the setting of equity markets but also widely seen in international trade and consumption. With regard to equities, French and Poterba (1991) notably document that U.S. investors held approximately 94 percent of their portfolio domestically at the end of the 1980s. Such estimations violate the fundamentals of portfolio theory since the actual portfolios do not lie on the efficient frontier and, hence, bear idiosyncratic risk which is not rewarded by the market. Moreover, this seems to contradict the assumption of rational investors. This gap between theoretical portfolio models and the actual composition of investors’ portfolios has drawn a lot of attention in financial research. A substantial body of literature confirmed the existence of home bias, but in spite of a variety of explanation attempts, the underlying rationale remains puzzling. In the elaboration in section 3, stock prices are treated as exogenous. The implications on stock prices are in the focus of section 4.
In addition to home bias, recent evidence suggests a local bias in the national context, meaning that investors tend to overweight local securities compared to distant ones. According to Coval and Moskowitz (1999), the typical portfolio of the mutual fund managers in the U.S. comprises stocks of companies which are located between 160 and 184 kilometers closer to the manager’s office than the average U.S. company is. In other words, the average manager holds stocks that are around ten percent geographically closer than the average stock in his benchmark portfolio. This implies a significant geographic preference for local investments.
Summary of Chapters
1 Introduction: This chapter defines the research problem regarding the impact of corporate headquarters' location on stock returns and outlines the structure of the analysis.
2 The Fundamentals of International Capital Markets: This section introduces the theoretical framework of portfolio optimization, market efficiency, and international diversification.
3 Home Bias and Local Bias in Equities: This chapter provides an extensive overview of home and local bias, presenting various academic explanation attempts from institutional to behavioral perspectives.
4 Geographic Component of Asset Pricing: This section analyzes the role of headquarters' location, agglomeration effects, and develops hypotheses regarding the geographical impact on stock returns.
5 Description of the Data Set: This chapter describes the data selection process for German corporations and provides descriptive statistics for the sample.
6 Empirical Analysis: This core chapter presents the methodology and results of time-series, cross-sectional, and panel regressions to test the formulated hypotheses and assess the robustness of the findings.
7 Summary and Conclusion: This final chapter synthesizes the main empirical findings and discusses the implications for investors, corporations, and future research.
Keywords
Home Bias, Local Bias, Asset Pricing, Corporate Headquarters, Portfolio Theory, Market Efficiency, Behavioral Finance, Comovement, Geographic Segmentation, International Diversification, Firm Determinants, Regional Determinants, Germany, CDAX, Investment Sentiment
Frequently Asked Questions
What is the core subject of this thesis?
The thesis examines the impact of the geographical location of corporate headquarters on stock returns, specifically focusing on how the "local bias" of investors influences asset pricing patterns.
What are the primary thematic fields covered?
The research combines international portfolio theory, market efficiency, behavioral finance, and economic geography to explain why investors prioritize local assets and how this affects stock market comovements.
What is the primary research question?
The analysis seeks to answer whether the location of corporate headquarters has a quantifiable impact on stock returns that can be attributed to the local bias of investors.
Which scientific methodology is applied?
The author uses empirical time-series, cross-sectional, and panel regressions to analyze the monthly stock returns of German corporations included in the CDAX between 1986 and 2005.
What topics are discussed in the main part?
The main part covers theoretical foundations of international capital markets, explanations for the home/local bias puzzle, the geographical implications of headquarters' locations, and a detailed empirical analysis of comovement and its determinants.
Which keywords best characterize this work?
Key terms include Home Bias, Local Bias, Asset Pricing, Geographic Comovement, and Corporate Headquarters.
Does the author find that geography affects stock returns?
Yes, the empirical results confirm a strong local comovement of stock returns, suggesting that geographical proximity is a significant factor in investor behavior and price formation.
Is the local comovement driven by economic fundamentals?
No, the study concludes that the observed local comovement is not sufficiently explained by macroeconomic fundamentals, supporting the view that geographical segmentation and correlated investor behavior play a larger role.
- Quote paper
- Michala Rudorfer (Author), 2007, The impact of headquarters location on stock returns, Munich, GRIN Verlag, https://www.grin.com/document/125573
