The Geography of Investment: Informed Trading and Asset Prices

Abstract

This paper uses geography to shed light on the role of asymmetric information in asset pricing. Demonstrating that investors possess significant informational advantages in evaluating nearby investments, we find that active mutual fund managers overweight proximate firms in their portfolios and earn substantial abnormal returns in local holdings. These findings are more pronounced among funds which are small, have few holdings, and operate out of remote locations. Aggregating across all funds, we use the fraction of a stock's shares held by local investors as a measure of the information asymmetry in its investor base. We find that a firm's degree of local ownership is positively related to the cross-section of expected returns, even when controlling for other factors known to explain return variation. The results document new evidence of informed trading and establish a link between such trading and asset prices.