Beware Of Financial Analyst Location Bias

You may be aware of home bias when it comes to investing, which is the tendency to oversaturate a portfolio with investments from your home country at the expense of international exposure. However, have you ever considered the biases of financial analysts, whose job it is to make stock recommendations (from buy to sell) and set price targets? A 2021 paper published in The Journal of Finance by Vesa Pursiainen does just that. It’s titled “Cultural Biases in Equity Analysis,” available here.

Pursiainen studies the effects of trust bias between European countries on European and U.K. financial analysts. He found that analysts tend to make more positive stock recommendations and set higher price targets for companies based in countries the analysts are more positively biased towards. In fact, this effect is stronger when a company’s nationality is more easily observable (such as when it is included in the company’s name). This makes sense since any bias based on nationality would become stronger if a company’s nationality is right in your face, impossible to ignore.

This effect was plain to see during Brexit, when the U.K. decided to leave the European Union. This decision resulted in increased British nationalism and more negative sentiment towards the U.K. on the part of Europeans. Accordingly, during this period, British analysts were 30% more likely to give a buy recommendation to a U.K. firm than European analysts.

Interestingly, Pursiainen also found that the trust bias effect is stronger during periods of negative economic sentiment, in particular during recessions. This suggests that negative economic periods may bring out analysts’ cynicism and amplify biases. On the other hand, economic prosperity can allow for these biases to fade as analysts get caught up in the thrill of a bull market.

Whether or not these findings also apply to U.S.-based financial analysts is unclear. Future research should investigate whether there is a similar bias effect at the state level or if this is only found to be significant at the country level. In any case, if you are making investment decisions based on analyst recommendations and price targets, it’s worth taking a look at their nationality and considering if there may be any effect of trust bias.

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