There is an interesting story in the Sunday New York Times about a recent study by George Korniotis (Fed Bd of Governors) and Alok Kumar (Texas Business), entitled "Long Georgia, Short Colorado: The Geography of Return Predictability" (on SSRN here).
In a nutshell, the article documents that individual investors are overinvested in businesses that are located closer to them. Thus, when state or regional economic conditions deteriorate relative to the country as a whole, the sale of stocks--to maintain one's standard of living--has a predictable, disproportionate effect on the stock prices of companies headquartered nearby. There is also some interesting methodology in this paper, at least for those of us interested in testing the effects of geography on business or law. Here is article abstract:
This paper shows that returns of U.S. state portfolios are predictable. In the presence of local bias and incomplete risk sharing, consumption smoothing motives of local investors generate predictable patterns in the returns of local stocks. Specifically, local investors require higher average future returns to hold risky local stocks when local economic conditions worsen and they face stronger borrowing constraints. The state portfolio returns are predictable both in the short-run (one quarter ahead) and the long-run (up to 24 quarters ahead). The predictability is stronger among less visible firms and in regions where investors exhibit stronger local bias and hold more concentrated portfolios. Trading strategies that exploit the state-level predictability earn annual risk adjusted returns of around 6-8%. Overall, these results indicate that the stock return generating process contains a predictable local component.
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