The Only Game in Town: Stock-Price Consequences of Local Bias

Theory suggests that, in the presence of local bias, the price of a stock should be decreasing in the ratio of the aggregate book value of firms in its region to the aggregate risk tolerance of investors in its region. Using data on U.S. states and Census regions, we find clearcut support for this proposition. Most of the variation in the ratio of interest comes from differences across regions in aggregate book value per capita. Regions with low population density—e.g., the Deep South—are home to relatively few firms per capita, which leads to higher stock prices via an “only-game-in-town” effect. This research is supported by the National Science Foundation. We are grateful for the comments of Gur Huberman, Alok Kumar, Jake Thomas, Scott Weisbenner, the referee, and seminar participants at USC, Harvard Business School, the Yale School of Management, Princeton, the University of Iowa Behavioral Finance conference, and the Western Finance Association meetings.