Volume
2, Number 1, 2001 Abstracts
©
Copyright Erlbaum 2001
EDITORIAL
COMMENTARY
The Effects of Subject Pool and Design Experience on
Rationality in Experimental Asset Markets
Lucy F. Ackert
Bryan K. Church
Empirical evidence suggests that prices do not always reflect fundamental
values and individual behavior is often inconsistent with rational expectations
theory. We report the results of fourteen experimental asset markets designed
to examine whether the in-teractive effect of subject
pool and design experience (i.e., previous experience in a market under
identical conditions) tempers price bubbles and improves forecasting ability.
Our main findings are: 1) price run-ups are modest and dissipate quickly when
traders are knowledgeable about financial markets and have participated in a
previous market under identical conditions; 2) price bubbles moderate quickly
when only a subset of traders are knowledgeable and experienced; 3) the
heterogeneity of expectations about price changes is smaller in markets with
knowledgeable and experienced traders, even if such traders only represent a
subset of the market; and 4) individual forecasts of prices are not consistent
with the predictions of the rational expectations model in any market, although
absolute forecast errors are smaller for subjects who are knowledgeable of
financial markets and for those subjects who have participated in a previous
market. In sum, our findings suggest that markets populated by at least a
subset of knowledgeable and experienced traders behave rationally, even though
average individual behavior can be characterized as irrational.
The Influence of Gender on the Perception and
Response to Investment Risk: The Case of Professional Investors
Robert A. Olsen
Constance M. Cox
In a previous issue of this journal, O'Barr and
Conley, noted that cultural differences caused public pension fund managers to
invest differently and more conservatively than their private fund
counterparts. An additional insight to is that
cultural factors have a non-trivial affect on how assets are managed. This
article continues with this theme and suggests that, even with equivalent
training, experience and information, investment managers make different
decisions based on identifiable cultural differences. This study focuses on
professional men and women investment managers who perceive and respond to risk
differently. This supports O'Barr and Conley,
suggesting cultural factors may be responsible for this risk related gender
effect. There is extensive evidence that when faced with social and
technological hazards, women are more risk averse than men. This appears to be
so even when decision-makers of both genders have the same level of expertise
and experience. In the investment realm, non-professional women investors also
appear to accept less risk than their male counterparts, after controlling for
factors such as age, education, wealth and experience. Although the precise
reason for this gender difference in risk taking is un-known, it appears to be
related to evolutionary and social factors. This paper is unique in that it
investigates the risk/gender difference for professionally trained investors.
It is found that women investors weight risk
attributes, such as possibility of loss and ambiguity, more heavily than their
male colleagues. In addition, women tend to emphasize risk reduction more than
men in portfolio construction. While gender differences appear to influence
perceptions of risk and recommendations to clients, these differences tend to
be the most significant for assets and portfolios at risk extremes.
The
Psychology of Financial Decision-Making: Applications to Trading, Dealing, and
Investment Analysis
Denis J. Hilton
This paper offers a whole range of areas in which
the latest work on psychology, social psychology and behavioral finance could
offer competitive advantage both to financial markets as well as individual
firms. The aim is to identify potential applications of experimental and
organizational psychology to improve the efficiency of financial institutions.
The focus is on two major areas of application: trading and dealing in currencies,
and investment decision-making. The paper reviews the seven deadly sins in
individual decision-making showing how the financial decision-maker may fall
prey to them. It also suggests how this knowledge can be put to use in
improving efficiency in financial strategy, marketing, and human resource
management (selection, training, decision-aiding, and control). The paper
concludes by identifying important questions for the financial markets to
consider if they are serious about improving managerial practices.
Book
Review by Jason Zweig: The Perception of Risk, Paul Slovic,
2000,
Volume
2, Number 2, 2001 Abstracts
©
Copyright Erlbaum 2001
Training Novice
Investors to Become More Expert: The Role of Information Accessing Strategy
Jacob Jacoby
Maureen Morrin
Gita Johar
Zeynep Gürhan
Alfred Küss
David Mazursky
Considerable research has
examined how securities information, once accessed, is cognitively processed to
arrive at buy, sell or hold decisions. In contrast, this paper ex-amines
whether training novice investors to simply apply the information accessing
strategies used by better-performing security analysts, prior to actual
cognitive processing of the information, would improve their performance. We
obtain performance differences by comparing trained subjects who used the
recommended strategies with untrained subjects. Notably, these differences
emerged even during a significant market downturn during the simulation.
Implications of the findings and directions for future research are discussed.
Financial
Bubbles: Excess Cash, Momentum, and Incomplete Information
Gunduz Caginalp
David Porter
Vernon Smith
We report on a
large number of laboratory market experiments demonstrating that a market
bubble can be reduced under the following conditions: 1) a low initial
liquidity level, i.e., less total cash than value of total shares, 2) deferred
dividends, and 3) a bid—ask book that is open to traders. Conversely, a large
bubble arises when the opposite conditions exist.
The first part of the article is comprised of twenty-five experiments with
varying levels of total cash endowment per share (liquidity level), payment or
deferral of dividends and an open or closed bid—ask book. We find that the
liquidity level has a very strong influence on the mean and maximum prices
during an experiment (P < 1/10,000). These results suggest that within the
framework of the classical bubble experiments (dividends distributed after each
period and closed book), each dollar per share of additional cash results in a
maximum price that is $1 per share higher. There is also limited statistical
support for the theory that deferred dividends (which also lower the cash per
share during much of the experiment) and an open book lead to a reduced bubble.
The three factors taken together show a striking difference in the median
magnitude of the bubble ($7.30 versus $0.22 for the maximum deviation from
fundamental value).
Another set of twelve
experiments features a single dividend at the end of fifteen trading periods
and establishes a 0.8 correlation between price and liquidity during the early
periods of the experiments. As a result, calibration of prices and evolution
to-ward equilibrium price as a function of liquidity are possible.
Investing
in Frankenfirms: Predicting Socially Unacceptable
Risks
Baruch Fischhoff
Alain Nadaï
Ilya Fischhoff
When the public decides that a product or production process
is socially unacceptable, the share price of the firms involved may suffer. The
danger is that, out of distaste, people will refrain from buying the product or
the shares. But being able to assess the degree of unacceptability can mean
being better able to assess how it will affect a firm's profitability, and
being better able to assess the value of a firm. Over the past twenty-five
years, many psychological studies have considered predictors of unacceptability
for one class of industrial activities: those perceived as producing risks to
health, safety, and the environment.
We compare results from
several studies of risk perception conducted from 1975—1994 with current
consumer boycotts and the screening criteria of socially responsible investment
firms–two forms of organized distaste. From both perspectives, high historic
ratings on undesirable risk characteristics have predicted current organized
aversion. These relationships are discussed in terms of how to make more
precise estimates of the direct and indirect effects of social unacceptability
on share price. One way is to pay critical attention to the financial
disclosures of firms that may have such problems in light of the concurrent
state of scientific knowledge. We illustrate these issues with the case of
genetically modified organisms.
Volume
2, Number 3, 2001 Abstracts
©
Copyright Erlbaum 2001
Unconscious Herding Behavior as the Psychological Basis of
Financial Market Trends and Patterns
Robert R. Prechter, Jr.
Human herding
behavior results from impulsive mental activity in individuals responding to
signals from the behavior of others. Impulsive thought originates in the basal
ganglia and limbic system. In emotionally charged situations, the limbic
system's impulses are typically faster than rational reflection performed by
the neocortex. Experiments with a small number of
naïve individuals as well as statistics reflecting the behavior of large groups
of financial professionals provide evidence of herding behavior. Herding
behavior, while appropriate in some primitive life-threatening situations, is
inappropriate and counter-productive to success in financial situations.
Unconscious impulses that evolved in order to attain positive values and avoid
negative values spur herding behavior, making rational independence extremely
difficult to exercise in group settings. A negative feedback loop develops
because stress increases impulsive mental activity, and impulsive mental
activity in financial situations, by inducing failure, increases stress. The
interaction of many minds in a collective setting produces super-organic
behavior that is patterned according to the survival-related functions of the
primitive portions of the brain. As long as the human mind comprises the triune
construction and its functions, patterns of herding behavior will remain
immutable.
A Report
on the March 2001 Investor Sentiment Survey
David Dreman
Stephen Johnson
Donald MacGregor
Paul Slovic
Steep declines in
the value of publicly traded stocks in the first quarter of 2001 left many
market observers speculating whether investor sentiment had undergone a
significant and negative change, and whether investors would subsequently flee
stocks in favor of less volatile investment options. A survey study of investor
expectations and confidence was conducted in late March 2001 to capture
investor sentiment and compare it with similar measures taken in surveys
conducted in 1998 during a period of rapid market incline. The surprising
results are that there are only minor differences in investor sentiment in
terms of: (a) confidence in the long and intermediate performance of the stock
markets; (b) composition of stocks versus bonds in their portfolios; (c) the
intention to buy on the dips; (d) the amount of risk investors plan to
undertake. The high level of investor confidence observed in 2001 (in spite of
a severe drop in market value) is potentially accounted for by psychological
processes that influence investor judgment. These processes include reliance on
image-driven affective evaluations of common stocks that contribute to
excessive optimism.
A
Behavioral Model of Stock Market Investors' Impact on Consumption
Samuel B. Bulmash
This paper offers
a theory of investor/consumer behavior in the context of an adaptive relationship.
It shows how consumer spending and stock market gains and losses interact in a
"gradual diffusion" process. The model offers predictions about
likely changes in investor behavior, and the impact on the underlying economy
in general and consumption in particular. These predictions are validated
empirically. Specifically, the paper finds that investors/consumers gradually
smooth their "wealth spending" and accelerate consumption as they
become more convinced that their gains are permanent.
This is somewhat reminiscent of the "income smoothing" suggested by Friedman [1957]. We present evidence that the consumption wealth spending peaks at approximately 2.5%—3% of the stock market wealth cumulative gain in the previous twelve- to twenty-four-month period, while concurrent effects are negligible. The results also provide a partial explanation for the long cycle of a strong economy in the 1990s, and point out the danger to the economy from a prolonged stock market decline.
On
Ignorance, Intuition, and Investing: A Bear Market Test of the Recognition
Heuristic
Michael Boyd
This study
replicates recent tests of the recognition heuristic as a device for selecting
stock portfolios. The heuristic represents a lower limit to the search for
information, since simple name recognition is the least one can know about
anything. Gigerenzer and others conducted original
experiments in this field at the Max Planck Institute for Psychological
Research's Center for Adaptive Behavior and Cognition (the "ABC Research
Group"). The ABC Group's tests support the use of the heuristic in a bull
market environment. This study, conducted in a down market, reaches a different
conclusion: Not only can a high degree of company name recognition lead to
disappointing investment results in a bear market, it
can also be beat by pure ignorance. Virtually the only finding of the ABC
Group's study that we match here is that Americans are not very good at picking
American stocks to outperform the market.
Volume
2, Number 4, 2001 Abstracts
©
Copyright Erlbaum 2001
Toward an
Understanding of the Risky Choice Behavior of Professional Financial Analysts
James E. Hunton
Ruth Ann McEwen
Sudip Bhattacharjee
Several studies have reported
inefficiencies and/or biases in analysts'ability to incorporate
new information into their earnings forecasts. We propose that an important
psychological factor associated with optimistic earnings forecasts is the
propensity of analysts to engage in risky choice behavior as described by
prospect theory. Furthermore, the motivational incentives faced by analysts may
exacerbate risky choice behavior during forecast revision, thereby magnifying
overestimates of earnings. Sixty professional financial analysts were asked to
issue a first quarter and then an annual EPS forecast of a company. The
analysts were randomly assigned to two initial forecast accuracy conditions
that indicated their initial forecast earnings was 1) essentially the same as
actual earnings, or 2) substantially higher than actual earnings. Analysts were
also assigned to one of three motivational incentive conditions indicating the
analyst and brokerage firm would 1) have no future contact with the fore-cast
firm, 2) begin to follow the forecast firm, or 3) establish an underwriting
relationship with the forecast firm. The results indicate that analysts who
perceived a loss function due to the inaccuracy of prior earnings forecasts
tended to choose riskier prospects in subsequent forecast revisions than
analysts who perceived their prior earnings forecasts to be ac-curate. These
riskier prospects translate into greater overestimates of earnings.
Furthermore, while the average risk attitude of the analysts was optimistic,
higher levels of motivational incentives were associated with greater risk-seeking
behavior by the analysts who perceive a loss function. It appears that the
motivational incentives inherent in brokerage firms can exacerbate the risky
choice behavior of financial analysts during forecast revision. These findings
support the utility of incorporating both cognitive and motivational factors
into the prediction of analyst behavior.
Momentum,
Rational Agents and Efficient Markets
John Crombez
Descriptive
behavioral models explain the momentum anomaly by assuming that financial
agents are irrational. However, investors are not tested to be susceptible to
the cognitive failures observed in psychological experiments. We consider an
environment where financial agents are rational, markets are efficient as
defined by the Grossman—Stiglitz [1980] efficiency,
and there are market imperfections in the information market. Based on a
simulation experiment, we find that returns on momentum strategies can exist in
this environment because of the noise in expert information. We empirically
find that even in a sample of large and liquid stocks, this noise is still
ob-servable and, hence, momentum can be empirically found for these samples
even when agents are rational and markets are efficient.
Visibility,
Institutional Preferences and Agency Considerations
Lucy F. Ackert
George Athanassakos
We show that market frictions and
agency considerations are important concerns when institutional investors make
portfolio allocation decisions. For a sample of widely followed firms,
institutional holdings increase with increases in visibility as measured by the
number of analysts following the firm. We also report a significant seasonal
pattern in institutional holdings consistent with the gamesmanship hypothesis,
which asserts that institutions rebalance their portfolios in response to
agency considerations. Finally, we find that excess returns are highly seasonal
with performance, deteriorating when the following by financial analysts
increases. "Followed" firms actually exhibit inferior market performance
over the 1981—1996 sample period.
Are
Malaysian Investors Rational?
Ming-Ming Lai
K. L. T. Low
Ming-Ling Lai
This paper
examines the investment practices of Malaysian institutional investors during
the bullish and bearish periods. The factors and forces that drive the
Malaysian stock market are also identified. The investors used a lot of
information within and outside the firm before making any stock selection. The
analysis of fundamentals appears to be the most popular method for share
appraisal. The survey findings demonstrated that Malaysian investors appeared
to be rational and prudent in making financial decisions.
An
Experimental Study of the Disposition Effect: Evidence From
Macau
Peter M. W. Chui
The disposition
effect–the tendency to sell winning transactions too soon and hold losing
transactions too long–is examined experimentally in