Local Institutional Investors, Information Asymmetries, and Equity Returns

Abstract

Using geographically proximate institutions as a close approximation to informed investors, this paper examines the informational role of institutional investors in stock markets. We find that both the level of and change in local institutional ownership predict future stock returns; in contrast, such predictive abilities are relatively weak for nonlocal institutional ownership. Moreover, the positive relation between local institutional holdings and stock performance is pronounced in firms with high information asymmetry. The positive relation is also more evident for holdings by institutions that are more likely to possess and exploit local information, such as local investment advisors, high local ownership institutions, and high local turnover institutions. Finally, we find that the stocks that local institutional investors hold (trade) earn higher excess returns around future earnings announcements than those that nonlocal institutional investors hold (trade). These findings suggest that geography proxies for the availability of information and allows local institutional investors to execute profitable trades based on their superior information.