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Measuring the effects of geographical distance on stock market correlation

Author

Listed:
  • Eckel, Stefanie
  • Löffler, Gunter
  • Maurer, Alina
  • Schmidt, Volker

Abstract

Recent studies suggest that the correlation of stock returns increases with decreasing geographical distance. However, there is some debate on the appropriate methodology for measuring the effects of distance on correlation. We modify a regression approach suggested in the literature and complement it with an approach from spatial statistics, the mark correlation function. For the stocks contained in the S&P 500 that we examine, both approaches lead to similar results: correlation increases with decreasing distance. Contrary to previous studies, however, we find that differences in distance do not matter much once the firms' headquarters are more than 40 miles apart, or separated through a federal border. Finally, we show through simulations that distance can significantly affect portfolio risk. Investors wishing to exploit local information should be aware that local portfolios are relatively risky.

Suggested Citation

  • Eckel, Stefanie & Löffler, Gunter & Maurer, Alina & Schmidt, Volker, 2009. "Measuring the effects of geographical distance on stock market correlation," SFB 649 Discussion Papers 2009-025, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
  • Handle: RePEc:zbw:sfb649:sfb649dp2009-025
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    References listed on IDEAS

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    3. Joshua D. Coval & Tobias J. Moskowitz, 2001. "The Geography of Investment: Informed Trading and Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages 811-841, August.
    4. Christo Pirinsky & Qinghai Wang, 2006. "Does Corporate Headquarters Location Matter for Stock Returns?," Journal of Finance, American Finance Association, vol. 61(4), pages 1991-2015, August.
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    More about this item

    Keywords

    stock returns; residual correlation; mark correlation function; geographical comovement; portfolio analysis;
    All these keywords.

    JEL classification:

    • R12 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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