Abstract We examine the influence of financial asset historical price path characteristics on investors’ risk perception, return beliefs and investment propensity. To that end, we run a series of survey experiments in which we present various price patterns to individuals with vested interest in financial matters. Our findings reveal that price paths with identical daily and monthly returns (and consequently identical return standard deviation) can lead to substantially different risk perception by investors, indicating that historical volatility is insufficient to explain risk perception. Salient features such as highs, lows and crashes are the most influential drivers of perceived risk in price paths. Return forecasts are primarily driven by past overall returns and the most recent price developments. Perceived risk and return beliefs strongly predict investment propensity.
{"title":"What Makes an Investment Risky? An Analysis of Price Path Characteristics","authors":"Charlotte Borsboom, Stefan Zeisberger","doi":"10.2139/ssrn.3392623","DOIUrl":"https://doi.org/10.2139/ssrn.3392623","url":null,"abstract":"Abstract We examine the influence of financial asset historical price path characteristics on investors’ risk perception, return beliefs and investment propensity. To that end, we run a series of survey experiments in which we present various price patterns to individuals with vested interest in financial matters. Our findings reveal that price paths with identical daily and monthly returns (and consequently identical return standard deviation) can lead to substantially different risk perception by investors, indicating that historical volatility is insufficient to explain risk perception. Salient features such as highs, lows and crashes are the most influential drivers of perceived risk in price paths. Return forecasts are primarily driven by past overall returns and the most recent price developments. Perceived risk and return beliefs strongly predict investment propensity.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"332 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-10-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"122328313","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investors exhibit a robust and systematic pattern of shortening their holding period in a stock on which they execute multiple round trip trades. On average, the holding period shortens by 11% with each additional round trip. I show this tendency to be short-termed is associated with reinforcement learning. Investors are more likely to shorten the holding period after a round trip where they could have realized a better return had they sold earlier. Investors become short-termed as they become more familiar with trading a stock.
{"title":"Familiarity Breeds Short-Termism","authors":"Ellapulli V. Vasudevan","doi":"10.2139/ssrn.3474332","DOIUrl":"https://doi.org/10.2139/ssrn.3474332","url":null,"abstract":"Investors exhibit a robust and systematic pattern of shortening their holding period in a stock on which they execute multiple round trip trades. On average, the holding period shortens by 11% with each additional round trip. I show this tendency to be short-termed is associated with reinforcement learning. Investors are more likely to shorten the holding period after a round trip where they could have realized a better return had they sold earlier. Investors become short-termed as they become more familiar with trading a stock.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-10-23","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"115772697","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We show that stock prices underreact when there is a political event, reflected in higher momentum returns. We conjecture that political news crowds out stock news cause investors to distract, trade more indexes and underreact to firm specific news. We analyze momentum returns following general election day, and find 8.8% increase in momentum portfolio return. Our channel to identify higher momentum after elections encompasses both rational and behavioral parts. The rational part is due to political uncertainty around elections, and the behavioral part is due to investors’ distraction. Using Google trend data, we posit that investors change their news priorities to focus more on political news, and so some stock news slips under the radar. In sum, momentum strategies outperform during election cycles because investors’ distraction to stock market news.
{"title":"Political Momentum","authors":"Yosef Bonaparte","doi":"10.2139/ssrn.3460221","DOIUrl":"https://doi.org/10.2139/ssrn.3460221","url":null,"abstract":"We show that stock prices underreact when there is a political event, reflected in higher momentum returns. We conjecture that political news crowds out stock news cause investors to distract, trade more indexes and underreact to firm specific news. We analyze momentum returns following general election day, and find 8.8% increase in momentum portfolio return. Our channel to identify higher momentum after elections encompasses both rational and behavioral parts. The rational part is due to political uncertainty around elections, and the behavioral part is due to investors’ distraction. Using Google trend data, we posit that investors change their news priorities to focus more on political news, and so some stock news slips under the radar. In sum, momentum strategies outperform during election cycles because investors’ distraction to stock market news.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"28 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-09-26","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125689991","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Home Bias refers to the tendency to invest more heavily in one’s domestic equity market than global market-value proportions would suggest. Whether or not home-biased investing makes sense, the fact is that people in pretty much every country do it. This article addresses the question of whether if everyone’s doing it, does it matter? Or if everyone equally over-weights their domestic market does it all wash out, with the over-weights cancelling out the under-weights? We propose a simple model to answer this question, which produces surprising results.
{"title":"Home Biased: A Case for More Indexing","authors":"James White, Victor Haghani","doi":"10.2139/ssrn.3459557","DOIUrl":"https://doi.org/10.2139/ssrn.3459557","url":null,"abstract":"Home Bias refers to the tendency to invest more heavily in one’s domestic equity market than global market-value proportions would suggest. Whether or not home-biased investing makes sense, the fact is that people in pretty much every country do it. This article addresses the question of whether if everyone’s doing it, does it matter? Or if everyone equally over-weights their domestic market does it all wash out, with the over-weights cancelling out the under-weights? We propose a simple model to answer this question, which produces surprising results.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"2012 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-09-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"114583457","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Adam Zaremba, A. Szyszka, Andreas S. Karathanasopoulos, Mateusz Mikutowski
Abstract This paper shows that market breadth, i.e. the difference between the average number of rising stocks and the average number of falling stocks within a portfolio, is a robust predictor of future stock returns on market and industry portfolios for 64 countries for the period between 1973 and 2018. We link the market breadth with herd behavior and show that high market breadth portfolios significantly outperform low market breadth portfolios, and that this effect is robust to effects such as size, style, volatility, skewness, momentum, and trend-following signals. In addition, the role of market breadth is particularly strong among markets characterized by high limits to arbitrage, following bullish periods, and in collectivistic societies, supporting behavioral explanations of the phenomenon. We also examine practical implications of the effect and our results indicate that the effect may be employed for equity allocation and market timing, although frequent portfolio rebalancing can lead to higher transaction costs that may affect profitability.
{"title":"Herding for Profits: Market Breadth and the Cross-Section of Global Equity Returns","authors":"Adam Zaremba, A. Szyszka, Andreas S. Karathanasopoulos, Mateusz Mikutowski","doi":"10.2139/ssrn.3444882","DOIUrl":"https://doi.org/10.2139/ssrn.3444882","url":null,"abstract":"Abstract This paper shows that market breadth, i.e. the difference between the average number of rising stocks and the average number of falling stocks within a portfolio, is a robust predictor of future stock returns on market and industry portfolios for 64 countries for the period between 1973 and 2018. We link the market breadth with herd behavior and show that high market breadth portfolios significantly outperform low market breadth portfolios, and that this effect is robust to effects such as size, style, volatility, skewness, momentum, and trend-following signals. In addition, the role of market breadth is particularly strong among markets characterized by high limits to arbitrage, following bullish periods, and in collectivistic societies, supporting behavioral explanations of the phenomenon. We also examine practical implications of the effect and our results indicate that the effect may be employed for equity allocation and market timing, although frequent portfolio rebalancing can lead to higher transaction costs that may affect profitability.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"29 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-08-29","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128970881","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Investment organizations are complex to understand because decisions are the aggregation of multiple individuals who influence the process. This applies to organizations that apply both quantitative and qualitative investment approaches because the first step in a quantitative approach is still a qualitative statement of the investment hypothesis that is then formalized by the models. Increasingly, finance practice is starting to incorporate behavioral finance insights and recognize that individuals are not “rational utility maximizers”, but rather complex psychological beings that can exhibit non-traditional behaviors. Kahneman-Tversky (KT) introduced this notion of individuals being “humans” and not “econs” but made broad generalizations about behaviorally affected decisions (BADs) and did not provide a methodology to examine individual biases. A technique has been proposed to use KT’s questions to provide individual behavioral diagnostics and previous research demonstrated dramatic differences within and across groups based on age, gender and financial literacy, especially for gambles based on prospective gains and losses. This paper is a case study of a single asset management company that uses a mix of quantitative and qualitative investment techniques, driven by five decision makers with equally weighted votes in the final decision. In addition to demonstrating that each individual in the investment committee is unique and providing individual diagnostics that show that age, gender and education need not lead to a particular behavior, this paper highlights the fact that organizations have “investment tribes”; namely, that there are groups of individuals who appear to exhibit similar risk tendencies for gambles involving gains or losses. These tribes can influence and impact decision-making. Quantifying and making transparent the existence of these tribes could improve decision-making. This case study can be helpful for investment firms allowing them to become aware of potential biases, and also for asset owners that delegate decisions to third parties, as it allows them to understand how the investment firms they delegate to might behave when they experience drawdowns.
{"title":"Applying Behavioral Finance to Investments: The Existence and Importance of 'Investment Tribes'","authors":"Sid Muralidhar, A. Muralidhar","doi":"10.2139/ssrn.3437116","DOIUrl":"https://doi.org/10.2139/ssrn.3437116","url":null,"abstract":"Investment organizations are complex to understand because decisions are the aggregation of multiple individuals who influence the process. This applies to organizations that apply both quantitative and qualitative investment approaches because the first step in a quantitative approach is still a qualitative statement of the investment hypothesis that is then formalized by the models. Increasingly, finance practice is starting to incorporate behavioral finance insights and recognize that individuals are not “rational utility maximizers”, but rather complex psychological beings that can exhibit non-traditional behaviors. Kahneman-Tversky (KT) introduced this notion of individuals being “humans” and not “econs” but made broad generalizations about behaviorally affected decisions (BADs) and did not provide a methodology to examine individual biases. A technique has been proposed to use KT’s questions to provide individual behavioral diagnostics and previous research demonstrated dramatic differences within and across groups based on age, gender and financial literacy, especially for gambles based on prospective gains and losses. This paper is a case study of a single asset management company that uses a mix of quantitative and qualitative investment techniques, driven by five decision makers with equally weighted votes in the final decision. In addition to demonstrating that each individual in the investment committee is unique and providing individual diagnostics that show that age, gender and education need not lead to a particular behavior, this paper highlights the fact that organizations have “investment tribes”; namely, that there are groups of individuals who appear to exhibit similar risk tendencies for gambles involving gains or losses. These tribes can influence and impact decision-making. Quantifying and making transparent the existence of these tribes could improve decision-making. This case study can be helpful for investment firms allowing them to become aware of potential biases, and also for asset owners that delegate decisions to third parties, as it allows them to understand how the investment firms they delegate to might behave when they experience drawdowns.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"158 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-08-14","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126930972","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We provide novel evidence on which theories best explain stock return anomalies. Our estimates reveal whether anomaly returns arise from variation in the underlying firms' cash flows or their discount rates. For each of five well-known anomalies, we find that cash flow shocks explain more variation in anomaly returns than discount rate shocks. The cash flow and discount rate components of each anomaly's returns are negatively correlated. Most correlations between anomaly and market return components are small. Our evidence is inconsistent with theories of time-varying risk aversion and theories of common shocks to investor sentiment. It is most consistent with theories in which investors overextrapolate firm-specific cash flow news and those in which firm risk increases following negative cash flow news.
{"title":"What Drives Anomaly Returns?","authors":"Lars Lochstoer, Paul C. Tetlock","doi":"10.2139/ssrn.2808182","DOIUrl":"https://doi.org/10.2139/ssrn.2808182","url":null,"abstract":"We provide novel evidence on which theories best explain stock return anomalies. Our estimates reveal whether anomaly returns arise from variation in the underlying firms' cash flows or their discount rates. For each of five well-known anomalies, we find that cash flow shocks explain more variation in anomaly returns than discount rate shocks. The cash flow and discount rate components of each anomaly's returns are negatively correlated. Most correlations between anomaly and market return components are small. Our evidence is inconsistent with theories of time-varying risk aversion and theories of common shocks to investor sentiment. It is most consistent with theories in which investors overextrapolate firm-specific cash flow news and those in which firm risk increases following negative cash flow news.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"88 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125047513","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this study we investigate the effects of social considerations on the investment behavior of mutual fund managers. We propose a measure of investments in corporate social responsibility (CSR) by fund managers that captures the level of a manager’s tendency to invest in firms that engage in socially responsible activities. We find large and persistent cross-sectional variation in mutual funds’ CSR preferences. However, funds with greater CSR preference neither deliver higher returns nor enjoy higher flows. Religious belief, on the other hand, is shown to have a positive impact on a fund manager’s investment in firms with good CSR performance. We show funds that are located in highly religious areas and whose managers graduated from colleges in regions with high religiosity are more likely to invest in high-CSR stocks. Our results are consistent with non-pecuniary “pro-social” motives influencing the investment decisions of money managers.
{"title":"Religious Belief and Socially Responsible Investing","authors":"John Bae, Zheng Sun, Lu Zheng","doi":"10.2139/ssrn.3414530","DOIUrl":"https://doi.org/10.2139/ssrn.3414530","url":null,"abstract":"In this study we investigate the effects of social considerations on the investment behavior of mutual fund managers. We propose a measure of investments in corporate social responsibility (CSR) by fund managers that captures the level of a manager’s tendency to invest in firms that engage in socially responsible activities. We find large and persistent cross-sectional variation in mutual funds’ CSR preferences. However, funds with greater CSR preference neither deliver higher returns nor enjoy higher flows. Religious belief, on the other hand, is shown to have a positive impact on a fund manager’s investment in firms with good CSR performance. We show funds that are located in highly religious areas and whose managers graduated from colleges in regions with high religiosity are more likely to invest in high-CSR stocks. Our results are consistent with non-pecuniary “pro-social” motives influencing the investment decisions of money managers.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"94 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-07-03","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126983908","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In the present research, we document a novel forecasting bias, which we term the “future is now” (FIN) bias. Specifically, we show that people tend to believe that the future will mirror the present, even when such a belief is unfounded. That is, people overestimate the chances that whatever is happening now, will happen in the future, even when the (known) explicit probabilities of future outcomes contradict such a belief. This appears to be driven by an anchoring and (insufficient) adjustment process, whereby initial beliefs about the future are heavily influenced by the present circumstances, and then subsequent beliefs are not sufficiently adjusted once the probabilities of future outcomes are learned. Across nine studies (employing over 3,800 participants), we demonstrate the FIN bias in a variety of forecasting contexts, show that it manifests in incentive compatible settings, and provide evidence in support of an anchoring and (insufficient) adjustment mechanistic account.
{"title":"The 'Future Is Now' Bias: Anchoring and (Insufficient) Adjustment When Predicting the Future from the Present","authors":"Julian Givi, Jeff Galak","doi":"10.2139/ssrn.3409506","DOIUrl":"https://doi.org/10.2139/ssrn.3409506","url":null,"abstract":"In the present research, we document a novel forecasting bias, which we term the “future is now” (FIN) bias. Specifically, we show that people tend to believe that the future will mirror the present, even when such a belief is unfounded. That is, people overestimate the chances that whatever is happening now, will happen in the future, even when the (known) explicit probabilities of future outcomes contradict such a belief. This appears to be driven by an anchoring and (insufficient) adjustment process, whereby initial beliefs about the future are heavily influenced by the present circumstances, and then subsequent beliefs are not sufficiently adjusted once the probabilities of future outcomes are learned. Across nine studies (employing over 3,800 participants), we demonstrate the FIN bias in a variety of forecasting contexts, show that it manifests in incentive compatible settings, and provide evidence in support of an anchoring and (insufficient) adjustment mechanistic account.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"33 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-06-24","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131602883","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the profitability of momentum strategies for a sample of Core and Peripheral European equity markets. More specifically, a large number of strategies with different combinations of ranking and holding periods are empirically evaluated for the period between December 1989 to January 2018 for the UK, Germany, French, Sweden, the Netherlands, Italy, Spain, Greece, and Portugal. The results indicate that both the profitability and the optimal combination of ranking and holding periods of momentum strategies vary across markets.
{"title":"Are Momentum Strategies Profitable? Recent Evidence from European Markets","authors":"Anastasia Slabchenko","doi":"10.2139/ssrn.3397011","DOIUrl":"https://doi.org/10.2139/ssrn.3397011","url":null,"abstract":"This paper examines the profitability of momentum strategies for a sample of Core and Peripheral European equity markets. More specifically, a large number of strategies with different combinations of ranking and holding periods are empirically evaluated for the period between December 1989 to January 2018 for the UK, Germany, French, Sweden, the Netherlands, Italy, Spain, Greece, and Portugal. The results indicate that both the profitability and the optimal combination of ranking and holding periods of momentum strategies vary across markets.","PeriodicalId":365642,"journal":{"name":"ERN: Behavioral Finance (Microeconomics) (Topic)","volume":"6 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2019-05-31","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"123483561","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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