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Research
Patriotism impacts stock portfolio

"Buy American" is a steadfast patriotic refrain for many U.S. consumers, and it's also true for many Americans who invest in stocks, according to research at the Business School.

In their new study, "Patriotism in Your Portfolio," doctoral students Adair Morse and Sophie Shive explore the role of devotion and loyalty to one's country in explaining an "equity home bias."

Much like betting on the home team despite unfavorable odds or allocating retirement savings only to one's own company stock, patriotic investors choose to invest more of their stocks in firms based in their homeland. For example, U.S. investors hold 92 percent of their equity portfolio in domestic stock, although portfolio theory suggests the optimally diversified portfolio should consist of only one-third invested in domestic stocks.

"To some, the thought of betting against a home team or shorting employer stock may seem disloyal, and to others, the home team and the company stock are simply perceived as the best bets," Morse says. "The same patriotism-induced loyalty can be considered for international diversification."

Using data on 33 countries from the U-M World Values Survey, the researchers found that more patriotic countries and more patriotic regions within the United States hold smaller foreign equity positions—in other words, investors discriminate in favor of domestic stocks.

For example, Americans and South Africans invest less in foreign stocks than do several European investors, while investors in the region of Texas, Oklahoma, Louisiana and Arkansas—found by the survey to be very patriotic—invest less in international equities than do investors in New England—found by the survey to be less patriotic.

While prior research has provided four principal explanations for this home bias (transaction costs that limit investing abroad, lack of information about foreign equities, lack of familiarity with foreign investment opportunities and difficulty in estimating financial risk), the impact of patriotism on portfolio selection has not been examined previously, the researchers say.

After controlling for these standard explanations, Morse and Shive found that patriotism accounts for an additional 7 percent of the cross-country variation in foreign equity holdings. Further, a 10 percent decrease in patriotism is associated with a 29-48 percent increase in foreign equity in the home country portfolio.

The study also presented evidence that U.S. demand for French stocks traded in the United States declined in reaction to French opposition to the recent war in Iraq.

The proportion of American Deposit Receipts (ADRs) sold increased by 15-18 percent during the pre-war period of anti-French sentiment, and the average U.S. price of the ADR decreased relative to the French price. ADRs are certificates issued by a U.S. depository bank, representing foreign shares held by the bank.

Overall, Morse and Shive say their research has two implications: Patriotic behavior appears to explain a part of the mysterious equity home bias, and policies aimed at increasing investors' portfolio diversification may need to account for "irrational" investor behavior.

"Patriotism results in a winner's curse in the sense that the person valuing a stock most highly will ultimately be the highest bidder," Shive says. "The citizens of a country will likely be the highest bidders for their own country's assets, thus possibly driving up prices in their own market."

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