Using data on the investments a large number of individual investors made through a discount broker from 1991 to 1996, we find that households exhibit a strong preference for local investments. We test whether this locality bias stems from information or from simple familiarity. The average household generates an additional annualized return of 3.2% from its local holdings relative to its nonlocal holdings, suggesting that local investors can exploit local knowledge. Excess returns to investing locally are even larger among stocks not in the S&P 500 index (firms for which information asymmetries between local and nonlocal investors may be largest).Behold, the fool saith, "Put not all thine eggs in the one basket"-which is but a manner of saying, "Scatter your money and your attention"; but the wise man saith, "Put all your eggs in one basket and-watch that basket."Mark Twain, 1894 THE FINANCE LITERATURE HAS YIELDED a large number of in-depth studies concerning the investments managed by professional money managers, yet historically, relatively little has been known about the individual investors' money management, in no small part because of the shortage of high-quality data available for academic research. This is despite the fact that United States individual investors have been holding around 50% of the stock market in direct stock investments.The key issue we address in this paper is the availability of asymmetric information in financial markets, particularly in the context of geography of investment by individual investors. While it is well understood that there may be a number of determinants of the availability and quality of information about a company, including, for example, company size, number of analysts following * Both authors are from the Department of Finance, University of Illinois at Urbana-Champaign.Scott Weisbenner is with the NBER. We would like to extend our gratitude to an anonymous discount broker for providing the data on individual investors' positions, trades, and demographics. Special thanks to Terry Odean for his help in obtaining and understanding the data set. We thank Alok Kumar, Allen Poteshman, Mark Seasholes, and an anonymous referee for useful insights and helpful discussions. Both authors acknowledge the financial support from the College Research Board at the University of Illinois at Urbana-Champaign. Finally, we thank seminar participants at the University of Illinois and the 2003 Western Finance Association Meetings for their comments and constructive suggestions. 268The Journal of Finance it, and media coverage, it is reasonable to hypothesize that, ceteris paribus, investors may be able to gather value-relevant information about the companies local to them (henceforth local companies) with greater ease and accuracy than they could about remote companies (henceforth nonlocal companies). Indeed, Coval and Moskowitz (2001) demonstrate that professional managers' local investments outperform their remote investments, a finding that both provides a richer character...

This paper establishes a causal relation between an individual's decision whether to own stocks and average stock market participation of the individual's community. We instrument for the average ownership of an individual's community with lagged average ownership of the states in which one's nonnative neighbors were born. Combining this instrumental variables approach with controls for individual and community fixed effects, a broad set of time-varying individual and community controls, and state-year effects rules out alternative explanations. To further establish that word-of-mouth communication drives this causal effect, we show that the results are stronger in more sociable communities.STANDARD MODELS OF PORTFOLIO CHOICE typically assume that fully informed investors make rational asset allocation decisions to maximize lifetime utility. As Ellison and Fudenberg (1995 P. 93) note, however, "economic agents must often make decisions without knowing the costs and benefits of the possible choices" and thus often "rely on whatever information they have obtained via causal word-of-mouth communication." Given the evidence that average U. (2004) finds that nearly one-half of defined contribution plan participants report that they have little or no investment knowledge and fewer than 20% consider themselves relatively knowledgeable. Moreover, many respondents think that employer stock is less risky than a stock fund. 1510The Journal of Finance This paper empirically examines the inf luence of "community effects," in the form of word-of-mouth communication, on the decision about whether to participate in the stock market. In addition to its importance at the individual level, equity market participation is also important at the aggregate level because of its ability to inf luence the size of the equity premium (Mankiw and Zeldes (1991), Heaton and Lucas (2000), Brav, Constantinides, and Gezcy (2002)). It is also relevant for a variety of public policies, ranging from the incidence of dividend tax policy to whether investing Social Security surpluses in private investments can have real effects on the economy (Abel (2001), Diamond and Geanakoplos (2003)).Whereas standard models of portfolio choice indicate that most households should have equity market exposure, only one-third of U.S. households own stocks or stock mutual funds outside of retirement plans, and only one-half participate in the stock market even when retirement plans are included into the calculation.2 There are numerous reasons to suspect that one's decision about whether or not to invest in stocks may be inf luenced by the stock market participation of one's community by means of social interaction. Hong, Kubik, and Stein (2004) present a formal model and discuss several possible pathways for this effect. For example, social interaction may serve as a mechanism for information exchange by means of word-of-mouth communication or "observational learning" (Banerjee (1992), Bikhchandani, Hirshleifer, and Welch (1992), Fudenberg (1993, 1995)). Si...

Using data on the investments a large number of individual investors made through a discount broker from 1991 to 1996, we find that the stock trades by households with concentrated portfolios outperform those with diversified portfolios. While in general the stocks bought by individual investors significantly underperform the stocks they sell, the reverse is true for households whose holdings are concentrated in a few stocks. The excess return of concentrated relative to diversified portfolios is stronger for households with large account balances as well as for stocks not included in the S&P 500 Index and local stocks, potentially reflecting concentrated investors' successful exploitation of information asymmetries. This finding is very robust to alternative concentration measures and regression specifications, and to alternative explanations such as differences across concentrated and diversified investors in the portfolio turnover and access to inside information, suggesting that some of these concentrated households have superior information processing skills. Moreover, controlling for a household's average investment ability, the household's trades perform better as the household's portfolio includes fewer stocks. However, while concentrated household portfolios on average outperform diversified ones, their levels of total risk are larger and the Sharpe ratios of their stock portfolios are lower.

Using data on stock purchases individual investors made through a discount broker from 1991 to 1996, we study information diffusion effects-the relation between household investment choices and those made by their neighbors. A ten percentage point increase in neighbors' purchases of stocks from an industry is associated with a two percentage point increase in the household's own purchases of stocks from that industry, with the effect considerably larger for purchases of local stocks. The presence of information diffusion effects is robust to controls for potential inside information effects and to household fixed effects. Upon controlling for aggregate trading patterns, households' and neighbors' investment style preferences, and the industry composition of local firms, we attribute approximately one-third to one-half of the overall diffusion effect to word-of-mouth communication. Disentangling the overall diffusion effect suggests that the significant relation between our measures of information diffusion and subsequent industry-level returns appears to be driven by its word-of-mouth component.

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Using data on the investments a large number of individual investors made through a discount broker from 1991 to 1996, we find that the stock trades by households with concentrated portfolios outperform those with diversified portfolios. While in general the stocks bought by individual investors significantly underperform the stocks they sell, the reverse is true for households whose holdings are concentrated in a few stocks. The excess return of concentrated relative to diversified portfolios is stronger for households with large account balances as well as for stocks not included in the S&P 500 Index and local stocks, potentially reflecting concentrated investors' successful exploitation of information asymmetries. This finding is very robust to alternative concentration measures and regression specifications, and to alternative explanations such as differences across concentrated and diversified investors in the portfolio turnover and access to inside information, suggesting that some of these concentrated households have superior information processing skills. Moreover, controlling for a household's average investment ability, the household's trades perform better as the household's portfolio includes fewer stocks. However, while concentrated household portfolios on average outperform diversified ones, their levels of total risk are larger and the Sharpe ratios of their stock portfolios are lower.

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