Individual investors tend to tilt their portfolios towards local stocks. In the US, for instance, the typical household has about 30 per cent of its portfolio invested in stocks headquartered within a 250-mile radius of where it resides, even though only 12 per cent of all firms in the market are headquartered in the same radius on average. In China, individuals invest eight per cent more in firms from their province of residence than a market capitalization portfolio would predict. So what is the advantage of holding local stocks?

One theory is that investors are able to exploit non-public information given their proximity to company headquarters, and thereby achieve superior returns. However, evidence of this has been scarce. Mark Seasholes and Ning Zhu investigate to see if, indeed, local stocks offer an advantage to local investors.

They examine stock holdings and transactions for 43,132 households in the U.S. from 1991-96 and focus on the location of stock headquarters and the performance of stocks held and transacted. What they find turns the conventional view of holding local stocks on its head.

"The performance of portfolios of local holdings does not generate abnormal performance. And when it comes to transactions, the purchases of local stocks significantly underperform sales of local stocks. We conclude that individuals do not help incorporate value-relevant information about local into stock prices, directly contradicting existing studies," they say.

Local stock holdings outperform the market by only 0.8 per cent per year which is not economically significantly, indicating that investors do not appear to have relevant non-public information about the stocks they hold.

For transactions, purchases of local stocks fail to outperform sales of local stocks, also indicating that investors do not have information about these stocks. The average "buys-minus-sells" portfolio has a (negative) return of -1.7 per cent per year, and when this is limited to local non-S&P 500 index stocks, the result is worse, at -2.3 per cent per year.

"This is one of our most important findings. If individuals have any valuable information, we hypothesize the information is likely to be about local stocks with high levels of information asymmetries as would likely be found in local non-S&P 500 stocks. But when we focus only on these types of stocks, individual buys don't predict future price increases and individual sells don't predict future decreases. In fact we see the opposite," the authors say.

The data was run through many different specifications, such as by calendar year, different definitions of local and remote, and different measures of information asymmetry. The authors define "local" using radii of 100 miles and 100 km. The results still remained qualitatively similar.

"Our findings point to indexing as a straightforward solution to the perils faced by individual investors," the authors say.

"An investor who indexes can minimize transaction costs and avoid losses associated with trading individual stocks. On average individuals don't have value-relevant information about the local stocks they hold and trade," therefore there appears little to gain from trying to "beat the market" with these stocks.