Trust and Local Bias
Wei Chishen, Zhang Lei
Published in Journal of Financial and Quantitative Analysis, November 2020
Despite the well-known benefits from portfolio diversification, why do institutional investors still exhibit strong preferences for local stocks? A new study by Dr Lei Zhang, Associate Professor in the Department of Economics and Finance and co-author Chishen Wei of Singapore Management University proposes low social trust as an explanation.
The study uses datasets from the World Values Survey (WVS) and General Social Survey (GSS) to measure social trust, based on the survey question, “Generally speaking, would you say that most people can be trusted or that you need to be very careful in dealing with people?” The trust measure is then computed as the percentage of respondents who answer, “Most people can be trusted.”
The study finds that institutional investors in low trust regions in the United States tend to hold more local stocks than investors in high trust regions. Also, firms located in low trust regions tend to have greater local ownership than those in high trust regions. This is because when investors lack sufficient trust, they require better knowledge in their investment decisions, and possessing information advantage in local stocks helps to overcome this barrier. In areas where local amenities (e.g., prestigious golf courses) provide better opportunities to build social connections, the information advantage of low trust investors increases substantially.