DP8969 Local Bias and Stock Market Conditions

Author(s): Mariassunta Giannetti, Luc Laeven
Publication Date: May 2012
Keyword(s): behavioral finance, financial cycles, home bias, institutional investors, investor sentiment, local bias, market uncertainty, mutual funds, stock market
JEL(s): E32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8969

We show that the local bias in U.S. mutual fund portfolios varies significantly over time and is more pronounced at times of heightened market uncertainty, such as during financial crises. Similarly, the local bias is less pronounced in periods when market sentiment is strong. These results do not depend on past fund performance or fund inflows during good times. Additionally, we do not find that fund managers earn superior returns on local stocks during periods of heightened market uncertainty. Overall, we conclude that informational advantages or scale economies are unlikely to be important factors in explaining the dependence of local bias on market conditions, and that our evidence is more consistent with a behavioral explanation whereby changes in market conditions affect the preference for local stocks of ambiguity averse investors.