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Journal ArticleDOI

Proximity always matters : evidence from Swedish data

TL;DR: In this article, the authors investigated the impact of incomplete diversification and imperfect risk-sharing on asset returns and showed that the smaller a firm has, the larger the fraction of company idiosyncratic risk on average its investors have to carry, and the higher return they would demand for that.
Abstract: One of the main tenets of finance is diversification. Investors choose their portfolios so as to diversify away their idiosyncratic risk. In four essays included into this dissertation the implications of less than perfect diversification on investors’ performance and asset pricing are investigated. In Essay I we examine one particular instance in which diversification may play a role in a non-portfolio type of investment: the IPO. In an IPO, a set of potentially non-diversified investors – the existing shareholders – reduce their holdings of a company, listing the company and selling part of its shares. Our contribution is to show how portfolio diversification of controlling investors in private companies affects the IPO process. We demonstrate that companies sold by more diversified shareholders are less likely to be taken public, but when doing so they are priced more favourably. In Essays II and III we investigate the impact of incomplete diversification and imperfect risk-sharing on asset returns. Our argument is that the smaller shareholder base a firm has, the larger the fraction of company idiosyncratic risk on average its investors have to carry, and the higher return they would demand for that. We demonstrate that there is a negative and significant relationship between companies’ shareholder base and stock returns as well as between changes in shareholder base and stock returns. This effect is more pronounced for younger companies, but remains significant for seasoned companies as well. Applying our analysis to corporate events we demonstrate that abnormal performance following the repurchase can be partially explained by the reduction in the shareholders base resulting from repurchase. In Essay IV I investigate the motives behind one of the most puzzling examples of investors’ underdiversification – the local bias. Contrary to the predictions of classical financial theories, investors on aggregate overweight stock of proximate companies in their portfolios. I demonstrate that being placed in new community, individual investors not only soon become biased towards companies with establishments in this new locality, but they also obtain superior returns from these investments. Investing into the local stocks, therefore, is to a large degree rational.
Citations
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Journal ArticleDOI
TL;DR: In this paper, the authors exploit the restrictions of intertemporal portfolio choice in the presence of non-nancial income risk to design and implement tests of hedging that use the information contained in the actual portfolio of the investor.
Abstract: We exploit the restrictions of intertemporal portfolio choice in the presence of nonÞnancial income risk to design and implement tests of hedging that use the information contained in the actual portfolio of the investor. We use a unique dataset of Swedish investors with information broken down at the investor level and into various components of wealth, investor income, tax positions and investor demographic characteristics. Portfolio holdings are identiÞed at the stock level. We show that investors do not engage in hedging, but invest in stocks closely related to their non-Þnancial income. We explain this with familiarity, that is the tendency to concentrate holdings in stocks with which the investor is familiar in terms of geographical or professional proximity or that he has held for a long period. We show that familiarity is not a behavioral bias, but is information-driven. Familiarity-based investment allows investors to earn higher returns than they would have otherwise earned if they had hedged.

457 citations

Journal ArticleDOI
TL;DR: In this article, the authors examined the impact of geographic location on liquidity for U.S. rural-and urban-based companies and found that rural firms trade much less, are covered by fewer analysts, and are owned by fewer institutions than urban firms.

277 citations


Cites methods from "Proximity always matters : evidence..."

  • ...Bodnaruk (2003) uses data on Swedish investors’ stockholdings and home postal codes for every six months during 1995-2001....

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Journal ArticleDOI
TL;DR: In this article, the authors examined the impact of geographic location on liquidity for U.S. rural-and urban-based companies and found that rural firms trade much less, are covered by fewer analysts, and are owned by fewer institutions than urban firms.
Abstract: Our paper examines the impact of geographic location on liquidity for U.S. rural- and urban-based companies. Even after adjusting for size and other factors, rural firms trade much less, are covered by fewer analysts, and are owned by fewer institutions than urban firms. Trading costs are higher for rural Nasdaq firms, and volume that can be attributed to marketwide factors is lower for rural stocks. The findings add to our understanding of the way that access to information and familiarity affect liquidity.

237 citations


Cites methods from "Proximity always matters : evidence..."

  • ...Bodnaruk (2003) uses data on Swedish investors’ stockholdings and home postal codes for every six months during 1995-2001....

    [...]

Journal ArticleDOI
TL;DR: In behavioral portfolio theory, the optimal level of diversification in U.S. investors' equity portfolios is a puzzle as mentioned in this paper, which is solved in the context of behavioral portfolio theories, where risk aversion gives way to risk seeking at the uppermost layer.
Abstract: The levels of diversification in U.S. investors' equity portfolios present a puzzle. Today's optimal level of diversification, measured by the rules of mean–variance portfolio theory, exceeds 300 stocks, but the average investor holds only 3 or 4 stocks. The diversification puzzle can be solved, however, in the context of behavioral portfolio theory. In behavioral portfolio theory, investors construct their portfolios as layered pyramids in which the bottom layers are designed for downside protection and the top layers are designed for upside potential. Risk aversion gives way to risk seeking at the uppermost layer as the desire to avoid poverty gives way to the desire for riches. But what motivates this behavior is the aspirations of investors, not their attitudes toward risk. Some investors fill the uppermost layer with the few stocks of an undiversified portfolio; others fill it with lottery tickets. Neither lottery buying nor undiversified portfolios are consistent with mean–variance portfolio theory,...

178 citations

Journal ArticleDOI
TL;DR: In this paper, the authors consider a setting in which, due to borrowing constraints, individuals endowed with local resources underparticipate in financial markets, and show that rational agents may choose more extreme portfolios and amplify the effect.
Abstract: Within a rational general equilibrium model in which agents care only about personal consumption, we consider a setting in which, due to borrowing constraints, individuals endowed with local resources underparticipate in financial markets. As a result, investors compete for local resources through their portfolio choices. Even with complete financial markets and no aggregate risk, agents may herd into risky portfolios. This yields a Pareto-dominated outcome as agents introduce “community” risk unrelated to fundamentals. Moreover, if some agents are behaviorally biased, or cannot completely diversify their holdings, rational agents may choose more extreme portfolios and amplify the effect.

152 citations

References
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Journal ArticleDOI
TL;DR: The model financial economics encompasses finance, micro-investment theory and much of the economics of uncertainty as mentioned in this paper, and it has had a direct and significant influence on practice, as is evident from its influence on other branches of economics including public finance, industrial organization and monetary theory.
Abstract: THE SPHERE of model financial economics encompasses finance, micro investment theory and much of the economics of uncertainty. As is evident from its influence on other branches of economics including public finance, industrial organization and monetary theory, the boundaries of this sphere are both permeable and flexible. The complex interactions of time and uncertainty guarantee intellectual challenge and intrinsic excitement to the study of financial economics. Indeed, the mathematics of the subject contain some of the most interesting applications of probability and optimization theory. But for all its mathematical refinement, the research has nevertheless had a direct and significant influence on practice. ’ It was not always thus. Thirty years ago, finance theory was little more than a collection of anecdotes, rules of thumb, and manipulations of accounting data with an almost exclusive focus on corporate financial management. There is no need in this meeting of the guild to recount the subsequent evolution from this conceptual potpourri to a rigorous economic theory subjected to systematic empirical examination? Nor is there a need on this occasion to document the wide-ranging impact of the research on finance practice.2 I simply note that the conjoining of intrinsic intellectual interest with extrinsic application is a prevailing theme of research in financial economics. The later stages of this successful evolution have however been marked by a substantial accumulation of empirical anomalies; discoveries of theoretical inconsistencies; and a well-founded concern about the statistical power of many of the test methodologies.3 Finance thus finds itself today in the seemingly-paradoxical position of having more questions and empirical puzzles than at the start of its

5,672 citations

Journal ArticleDOI
TL;DR: For example, this paper found that men trade 45 percent more than women and earn annual risk-adjusted net returns that are 1.4 percent less than those earned by women, while women perform worse than men.
Abstract: Theoretical models of financial markets built on the assumption that some investors are overconfident yield one central prediction: overconfident investors will trade too much. We test this prediction by partitioning investors on the basis of a variable that provides a natural proxy for overconfidence--gender. Psychological research has established that men are more prone to overconfidence than women. Thus, models of investor overconfidence predict that men will trade more and perform worse than women. Using account data for over 35,000 households from a large discount brokerage firm, we analyze the common stock investments of men and women from February 1991 through January 1997. Consistent with the predictions of the overconfidence models, we document that men trade 45 percent more than women and earn annual risk-adjusted net returns that are 1.4 percent less than those earned by women. These differences are more pronounced between single men and single women; single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are 2.3 percent less than those earned by single women.

3,803 citations

Journal ArticleDOI
TL;DR: Theoretical models predict that overconedent investors trade excessively as mentioned in this paper, and they test this prediction by partitioning investors on gender by analyzing the common stock investments of men and women from February 1991 through January 1997.
Abstract: Theoretical models predict that overconedent investors trade excessively We test this prediction by partitioning investors on gender Psychological research demonstrates that, in areas such as enance, men are more overconedent than women Thus, theory predicts that men will trade more excessively than women Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997 We document that men trade 45 percent more than women Trading reduces men’s net returns by 265 percentage points a year as opposed to 172 percentage points for women It’s not what a man don’t know that makes him a fool, but what he does know that ain’t so Josh Billings, nineteenth century American humorist It is difecult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes Those possessed of superior information may trade speculatively, although rational speculative traders will generally not choose to trade with each other It is unlikely that rational trading needs account for a turnover rate of

3,292 citations

Journal ArticleDOI
TL;DR: In this paper, the empirical power and specification of test statistics in event studies designed to detect long-run (one to five-year) abnormal stock returns were analyzed and three reasons for this misspecification were identified.

2,946 citations


"Proximity always matters : evidence..." refers background or methods in this paper

  • ...I take the logarithm of the distance to capture the non-linearity of the effect documented in the earlier 6 Barber and Lyon (1997), p.172 7 Information on population distribution by administrative areas in Sweden can be found on the official website of central bureau of statistics of Sweden…...

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  • ...To calculate buy-and-hold abnormal returns I follow adopted control-firm methodology proposed by Barber and Lyon (1997)....

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Journal ArticleDOI
TL;DR: Barber and Lyon as mentioned in this paper analyzed tests for long-run abnormal returns and document that two approaches yield well-specified test statistics in random samples, but misspecification in non-random samples is pervasive.
Abstract: We analyze tests for long-run abnormal returns and document that two approaches yield well-specified test statistics in random samples. The first uses a traditional event study framework and buy-and-hold abnormal returns calculated using carefully constructed reference portfolios. Inference is based on either a skewnessadjusted t-statistic or the empirically generated distribution of long-run abnormal returns. The second approach is based on calculation of mean monthly abnormal returns using calendar-time portfolios and a time-series t-statistic. Though both approaches perform well in random samples, misspecification in nonrandom samples is pervasive. Thus, analysis of long-run abnormal returns is treacherous. COMMONLY USED METHODS TO TEST for long-run abnormal stock returns yield misspecified test statistics, as documented by Barber and Lyon ~1997a! and Kothari and Warner ~1997!. 1 Simulations reveal that empirical rejection levels routinely exceed theoretical rejection levels in these tests. In combination, these papers highlight three causes for this misspecification. First, the new listing or survivor bias arises because in event studies of long-run abnormal returns, sampled firms are tracked for a long post-event period, but firms that constitute the index ~or reference portfolio! typically include firms that begin trading subsequent to the event month. Second, the rebalancing bias arises because the compound returns of a reference portfolio, such as an equally weighted market index, are typically calculated assuming periodic ~generally monthly! rebalancing, whereas the returns of sample firms are compounded without rebalancing. Third, the skewness bias arises because the distribution of long-run abnormal stock returns is positively skewed, * Graduate School of Management, University of California, Davis. This paper was previously entitled “Holding Size while Improving Power in Tests of Long-Run Abnormal Stock Re

2,040 citations