Local Risk, Local Factors, and Asset Prices

Firm location affects firm risk through local factor prices. We find more procyclical factor prices such as wages and real estate prices in areas with more cyclical economies, namely high “local beta” areas. While procyclical wages provide a natural hedge against aggregate shocks and reduce firm risk, procyclical prices of real estate, which is part of firm's assets, increase firm risk. We confirm that firms located in higher local beta areas have lower industry-adjusted returns and conditional betas, and show that the effect is stronger among firms with low real estate holdings. A production-based equilibrium model explains these empirical findings.