Understanding ‘Home Bias’ in the Global Stock Market

Information asymmetries underlie stock price movements in financial markets when private information about a company becomes available to a set of outside investors. However, even with access to the same information, investors may process the implications of that information differently and come to conflicting conclusions about the underlying value of a company. In a new study, Yale economists Chunxin Jia, Yaping Wang, and Wei Xiong analyze the impact of “home bias” in the global stock market. In this context, home bias refers to the ways social and cultural connections impact not only the amount of company-specific information local and foreign investors can access but, more importantly, the way that investors process this information.

Using stock price data from a set of Chinese firms that were simultaneously cross listed locally on the Shanghai and Shenzhen stock exchanges, and abroad on the Stock Exchange of Hong Kong, the authors find that forecast revisions from local analysts were substantially more influential among domestic investors, while forecast revisions from international analysts were more influential among foreign investors, increasing or decreasing the stock price by a larger percent. Importantly, while residents of Hong Kong speak Cantonese, they have also been exposed to 150 years of British rule and English as an official language, as well as a different education curriculum than mainland Chinese residents. Therefore, Jia et al. treat residents of Hong Kong as “foreign,” and potentially more influenced by westernized investment philosophies, as compared to “local,” mainland Chinese investors.

Interestingly, the larger magnitude of increase or decrease in stock price for local companies in local stock exchanges versus foreign exchanges cannot be explained by factors such as local investors having better information about local firms or better access to reports from local analysts, nor by the idea that local analyst reports are somehow more precise. Instead, the differing price reactions appear to reflect a potential channel of social trust that impacts investors’ information processing. This causes local investors to have more trust in local analysts. In the same way, forecasts by foreign analysts provoke a significantly stronger reaction among foreign investors, relative to local investors. Similarly, Chinese investors react more strongly to forecasts from locally educated analysts versus foreign educated analysts, even when the latter are also Chinese.

These results suggest that a shared cultural background creates a social trust between investors and analysts. In addition, this research highlights the idea that foreign investors cannot simply hire local analysts to overcome any potential information gaps about a Chinese company. Despite the potential benefit of hiring a local analyst, the lack of social trust may prevent foreign investors from effectively relying on this information.

This behavior may help explain the “home bias” phenomenon in portfolio investment, where investors react more strongly to information about companies from their home countries. This may also help explain the higher level of volatility of foreign investors’ equity holdings, by implying that foreign investors have less trust in local companies, leading to higher turnover in the buying and selling of equity in these companies, which creates greater price volatility. Further research should investigate if these social connections are likely to persist as substantial sources of bias or if their effect will diminish as technological innovations create more globalized investors and analysts.

Article Source: Social Trust and Differential Reactions of Local and Foreign Investors to Public News. Chunxin Jia, Yaping Wang, and Wei Xiong, National Bureau of Economic Research, Working Paper, April 2015

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