The Geography of S&P 500 Stock Returns

Abstract

Investor bias in favor of geographically close firms has been documented in previous papers. An implication of this bias is that if local events cause nearby investors to trade together, then the correlation of stock returns of pairs of firms will increase as the distance between them decreases. We test this hypothesis using a sample of Standard & Poor's (S&P) 500 companies. After adjusting for industry effects and other factors, we find that the correlation coefficient between two stocks increases 12 basis points for every 100-mile reduction in distance. This result is consistent with local shocks affecting the returns of nearby firms by an average of approximately 43 basis points per month. We conclude these shocks are most likely the result of trading activity by local investors who own shares in nearby firms.

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