University of Texas at Austin

Monday, April 19, 2010

Profiting from IMBYs (people who Invest in My Back Yard)

Alok Kumar, finance professor

Alok Kumar, finance professor

The recession has been felt across the country, but some places have suffered more than others.

For example, Michigan’s 14.7 percent unemployment rate was the highest in the nation in March 2010. At 7.4 percent, Minnesota’s unemployment rate was high for the Land of 10,000 Lakes but still half of Michigan’s (click here for 10-year comparison).

Identifying those most-pained places could help investors make money, according to research from Alok Kumar, an assistant professor in the Department of Finance in the McCombs School of Business.

Kumar and George Korniotis, a staff economist at the Federal Reserve, have found that share prices of companies based in regions hard hit by recession go down and reach levels that become attractive to investors looking for good bargains.

Kumar shared the research with students at a McCombs School Faculty Research session recently. The sessions start at 5 p.m., which means pizza and soda are served. The students get a meal and find out what their professors are doing outside the classroom.

The research starts with the basic idea that many investors buy stocks in local companies.

In Austin that might mean buying shares of Dell, Whole Foods and National Instruments. Investors in Minnesota might buy 3M, Target, Best Buy and General Mills. Michiganders might buy the auto companies (oh wait, we’ve all got some of that action), Lazy Boy, Domino’s or Herman Miller.

When recession hits, investors want to reduce their risk so they start to reduce their stock holdings, which include those local companies. That, in turn, reduces the share prices of those local companies.

The researchers put the universe of publicly held stocks into state portfolios and crunched some numbers. They looked at unemployment rates, income figures and housing prices to determine where the good buys would be.

From 1980 through 2004 period, trading strategies that take advantage of the state-level predictability earn a return of more 7 percent per year on a risk-adjusted basis.

The idea for the hypothesis grew out of research by Kumar and Korniotis on how local bias affects investing.

To that they added the observation “that not all states are affected by the US recession to the same extent,” Kumar said. “We thought this must have some implications for market prices. And that’s what we found.”

Other McCombs faculty who presented research this academic year were Keith Brown, Robert McCulloch, Linda Golden, Patrick Brockett, Jim Fredrickson, Leon Lasdon and Bing Han.

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