How do institutional investors react to local shocks during a crisis? A test using the COVID‐19 pandemic

We examine how institutional investors reacted to geographically dispersed local shocks during the early stages of the COVID‐19 pandemic. A sample of real estate investment trusts (REITs) enables us to link two layers of geography: the locations of the assets in which the REITs were invested and the headquarters locations of institutional investors who owned REIT shares. We find that the institutional ownership of firms with an economic interest in the investors’ home markets declined more if those markets were heavily affected by the pandemic. In addition, the ownership responses to the COVID‐19 shock were larger in those markets in which REITs had larger portfolio allocations and in markets that were home to the investors. Importantly, we find that nonpassive and short‐term investors may have overreacted to the local shocks because their REIT portfolios subsequently underperformed relative to passive and long‐term investors. Our study highlights the importance of geography in the formation of investors’ expectations during market crises.