Volume
7, Number 1, 2006 Abstracts
©
Copyright Erlbaum 2006
Prediction
Markets and the Financial "Wisdom of Crowds"
Russ Ray-University of
This paper examines a new genre of behavioral marketsó"prediction" marketsóand their remarkable ability to flush out and thereafter aggregate inside and expert information regarding interest rates, exchange rates, inflation rates, stock prices, commodity prices, and many other economic and financial variables. Comprehensive studies of these markets have found that these markets have "proven to be uncannily accurate in predicting all types of events." Existing in cyberspace and being unregulated, these markets are, arguably, the most efficient financial markets in history.
The
Demographics of
As is well-known, investors are subject to overconfidence. Using a survey of about 2,000 defined contribution pension plan members, we not only corroborate this, but also explore the demographics of this behavioral flaw. Noting that overconfidence can be partitioned into certainty and knowledge, we find that highly-educated males who are nearing retirement, who have received investment advice, and who have experience investing for themselves, tend to have a higher certainty level. For some groups knowledge matches certainty. Because highly-educated males do not have higher levels of knowledge we conclude that they are more subject to overconfidence.
Subject
Perceptions of Confidence and Predictive Validity in Financial Information Cues
Dorla A. Evans-University of
Traditional financial theory holds that financial decision makers make choices based on an asset's mean return and its standard deviation in the context of the normal distribution. These statistics, however, may be vague concepts to decision makers, and more difficult to use relative to specific details of a simple discrete probability distribution. Therefore, this study shows which of ten information cues subjects use in making decisions designed to look like simplified bonds, stocks, and options. The cues consist of the mean, standard deviation, and other distribution features such as highest payoff. More importantly, this study relates subjects' usage of various information cues in making financial valuation judgments to their self-assessments of 1) an information cue's ability to best reveal the value of an asset (its predictive validity), and 2) their confidence in using that information cue. The results are related to the overconfidence literature in psychology.
Growth
Optimization with Downside Protection: A New Paradigm for Portfolio Selection
Jivendra K. Kale-St. Mary's
This study introduces growth optimization with downside protection as a portfolio selection technique based on power-log utility functions that combine long-term portfolio growth maximization with the behavioral tenets of prospect theory. This simple but powerful technique can be used with all types of assets, including those with highly skewed and fat-tailed return distributions. We use three assets with very different types of return distributions to show how effective this technique is in constructing portfolios with positively skewed returns that combine high upside potential with downside protection.
The
Platonic Foundations of Finance and the Interpretation of
Piotr Zielonka-
What is the nature of the collection of mathematical models we call "finance?" There is knowledge in finance, but what is the nature of it, and what is it really about? What sorts of justified true beliefs do we have, i.e., what would it mean for these beliefs/models to be true, and how do we justify their truth? The traditional positive interpretation of finance models poses a number of difficult, and perhaps even intractable, philosophical problems. There are as many as six other interpretations, only one of which, the normative interpretation, is familiar. Most of finance's interpretations of its models, including both of the usual ones, fall within the platonic/foundational perspective as it is applied to mathematics. Even the positive interpretation, to which most in finance implicitly or explicitly subscribe, does not reveal the "objective reality" that is supposed to be out there. We clearly need a truly "behavioral" finance, in every sense of the word.
Research
Elsewhere
Robert A. Olsen-Decision Science Research Institute
Book
Review
Robert A. Olsen-Decision Science Research Institute
Volume
7, Number 2, 2006 Abstracts
©
Copyright Erlbaum 2006
Searching
for Rational Investors in a Perfect Storm: A Behavioral
Disentangling
Cognitive Bias in the Assessment of Investment Decisions: Derivation of
Generalized Conditional Risk Attribution
Noriyuki Okuyama-Pareto Investment Management Limited
in
Gavin Francis-Pareto Investment Management Limited in
Conventional performance measurement methods concentrate on investment outcomes rather than the underlying investment process. This paper examines the effectiveness of the investment process by considering the essential part of any investment strategy: the investment decision. As recognized by Kahneman and Tversky [1979], the essential first step is to decompose returns into gains and losses. Using a fundamental investment decision matrix broadens the analysis beyond realized gains and losses to include an assessment of missed opportunities and losses avoided. This leads to an examination of investment strategies in terms of investment success versus error. We contrast these terms with traditional return and risk measures. The second step is to decompose investment decisions into the mutually exclusive categories of risk-taking and risk-reducing. Uncertainty observed in risk-taking activities is newly created at each manager's discretion, while the uncertainty in risk-reducing activities is already defined by an investor's portfolio. The conventional performance measurement approach fails to differentiate between these two types of decisions. The contrast between passive and active management styles of risk reduction becomes apparent from the perspective of investment success and error, particularly when using currency risk management as an illustration. Active information diagrams describe a geometric approach called conditional risk attribution. An active manager's skill lies in the ability to use information to maximize investment success and therefore minimize investment error. The choice of benchmark determines the degree of visibility of an investment exposure. We also address the problem of distinguishing between an active manager's skill and the uncontrollable impact of market movements. Having adjusted for the bias in an investment environment, it becomes possible, as a final step, to measure the information content of an active manager's strategy as the balance between investment success and error within a generalized conditional risk attribution framework. The unlimited nature of risk-taking decisions is evident when they are included in the framework. However, having defined an ex ante risk-taking limit, we can assess whether the choice of active manager has resulted in an enhancement of investment success over error. This allows investors to compare risk-taking managers with risk-reducing managers in the context of overall portfolio construction. The entire analysis is framed in terms of risk budgeting to demonstrate its general application to all asset classes and consequently to enhance total portfolio returns within the predetermined loss budget.
Money
Attitude Typology and Stock Investment
Carmen Keller-University of Zurich
Michael Siegrist-Swiss Federal Institute of
Technology in
This study identifies segments
of individual investors based on their money attitudes (attitude toward
financial security, attitude toward stock investing, obsession with money,
perceived immorality of the stock market, attitude toward gambling, interest in
financial matters, attitude toward saving, frankness
about finances). A cluster analysis of data from a representative mail survey
conducted in
Expanding
the Range of Behavioral Factors in Economic Simulations
H. Joel Jeffrey-Northern Illinois University
Economic simulations typically focus almost exclusively on economic variables. If non-economic factors are included at all, it is usually in some form of utility function calculation. This paper presents a model that allows formal specification of a much broader range of factors, processes, and quantities involved in human communitiesófamilies, businesses, ethnic groups, nations, work teams, cultures. The phenomena include the hierarchically structured social practices of the group, the principles that underlie choices in the community, and the recognizable positions or statuses in the community. This allows us to model intrinsic or expressive behavior, capturing the concept of multi-aspect identity and the impact of the principles of the group on individual behaviors, all in formal and quantitative form. Having these factors represented formally enables the creation of significantly more realistic simulations incorporating a much wider range of variables, particularly when the economic facts and quantities of interest are affected by and affect several other kinds of factors that are not, on their face, economic.
The
Disposition Effect and Individual Investor Decisions: The Roles of Regret and
Counterfactual Alternatives
Suzanne O'Curry Fogel,
Recent studies have documented a strong tendency for individual investors to delay realizing capital losses, while realizing gains prematurely (Odean [1996], Shefrin and Statman [1985], Weber and Camerer [1996]). This tendency has been termed the "disposition effect." The disposition effect is inconsistent with normative approaches to stock sales, such as those based on tax losses (see, for example, Constantinides [1983]). We surveyed individual investors, and found that more respondents reported regret about holding on to a losing stock too long than about selling a winning stock too soon. This finding suggests that individual investors are consistently engaging in behavior that they have been warned can cost them money and that they regret later. Two additional experiments confirm the disposition effect and the role of regret, and offer evidence about the role of an agent (broker) in the assignment of blame and regret. We show that investor satisfaction and regret are not simply functions of outcome, but are influenced by counterfactual alternatives and the type of action taken (holding versus selling). We suggest that the disposition effect may be highly related to reduction of anticipated regret.
Volume
7, Number 3, 2006 Abstracts
©
Copyright Erlbaum 2006
Did
Investor Sentiment Foretell the Fall of ENRON?
Harry F. Griffin-The
In the aftermath of the
ENRON Corporation failure, we acknowledge that many investors experienced a
financial loss when their ENRON equity holdings lost market value. Our research
centers upon the loss of that market value, and when the capital market first
signaled the positive potential of that loss. An examination of ENRON option
open interest from January 1, 2000 through December 31, 2001 reveals that such
information was available, observable, and inferential a year earlier.
The
Impact of
Rahul Verma-University of
Gökçe Soydemir-University
of Texas-Pan American
This study examines the
degree to which
Evidence
of the Endowment Effect in Stock Market Order Placement
Andreas Furche-Capital Markets Cooperative Research
Centre in Sydney
David Johnstone-University of
The psychological
endowment effect is apparent when investors place greater value on something
when they mentally "own" it than when someone else owns it. Although
this effect is well established in laboratory studies, there is relatively
little documented evidence of an endowment bias in actual trading. This study
examines order placements of stock traders on the Australian Stock Exchange.
Consistent with the endowment effect, sellers appear to value their own shares
higher than buyers independent of current market price, by consistently placing
sell orders on average "further from the market" (i.e., from the best
quote) than buy orders. This asymmetry is more pronounced in private client
trading than in orders made through institutional brokers, suggesting that more
sophisticated investors are less affected by asset ownership than the private
clients of retail brokers. Since private "day traders" have been able
to trade online themselves rather than through a
broker, the quote asymmetry relative to the best-standing quotes between asks
and bids has become more pronounced. Over the same period, the relatively small
asymmetry apparent in institutional quotes has remained unchanged.
Firm
Image and
Bryan K. Church-Georgia Tech
This paper documents the
importance of firm image in individual investment behavior. We conduct three
experiments designed to examine whether investment decisions are influenced by
selective information disclosures that are intended to promote a positive or
negative firm image. Importantly, the disclosures are not value-relevant.
Participants actively make investment decisions that have real economic
consequences. We find that participants invest more heavily in firms with a
positive image than in firms with a negative image, controlling for industry
membership and financial data. These results are consistent with economic
models of choice that recognize that the financial outcome is not the only
argument in a person's utility function.
The
Characteristics of Online Investors
Konari Uchida-The
Recent studies have documented a strong tendency for individual investors to delay realizing capital losses, while realizing gains prematurely (Odean [1996], Shefrin and Statman [1985], Weber and Camerer [1996]). This tendency has been termed the "disposition effect." The disposition effect is inconsistent with normative approaches to stock sales, such as those based on tax losses (see, for example, Constantinides [1983]). We surveyed individual investors, and found that more respondents reported regret about holding on to a losing stock too long than about selling a winning stock too soon. This finding suggests that individual investors are consistently engaging in behavior that they have been warned can cost them money and that they regret later. Two additional experiments confirm the disposition effect and the role of regret, and offer evidence about the role of an agent (broker) in the assignment of blame and regret. We show that investor satisfaction and regret are not simply functions of outcome, but are influenced by counterfactual alternatives and the type of action taken (holding versus selling). We suggest that the disposition effect may be highly related to reduction of anticipated regret.
Volume
7, Number 4, 2006 Abstracts
©
Copyright Erlbaum 2006
Exuberant
Irrationality: Judging Financial Books by their Covers
Andrew Coors – Laffer Associates
A
Literature Review of Social Mood
Kenneth R. Olson –
Emotions
exert a significant influence on financial behavior. The "socionomic hypothesis" posits social mood, the
collective mood of individuals, as a primary causal variable in financial and
social trends. In order to provide a scientific basis for the study of social
mood, this article reviews psychological research on major mood-related
elements of personality: affect, motivation, and personality traits. We examine
the structure and functions of these core personality dimensions, and discuss
research on contagion processes by which individuals' moods spread and manifest
in a collective social mood. We also address implications for financial and
economic behavior. Social mood is rooted in empirically established personality
dimensions that are fundamental to human nature, and can influence financial
outcomes.
Status
Quo Bias and the Number of Alternatives: An Empirical Illustration from the
Mutual Fund Industry
Alexander Kempf – University of Cologne
Stefan Ruenzi – University of Cologne
We examine
the extent of the status quo bias (SQB) in a real-world repeated decision
situation. Individuals who are subject to the SQB tend to choose an alternative
that they chose previously (i.e., their status quo), even if it is no longer
the optimal choice. We examine the
Recall of
Financial Information for Investment Decisions: The Impact of Encoding
Specificity and Mental Imagery
Kenneth Ryack –
Thomas Kida –
Given the
volume of data analyzed in investment decisions, analysts and investors often
must rely on their memory of financial information. Prior research suggests
that differences in the amount of information used by investors may affect
their valuation of securities and market prices. Thus, factors influencing the
amount and accuracy of information recalled could impact estimates of stock
value and market prices. Financial information is often presented in different
formats. This study examines whether differences in format presentation at
encoding and retrieval affect the recall of financial data. We also investigate
whether memory for financial information can be improved with a simple
technique that uses mental imagery to reinstate the original encoding
conditions. We find that even a minor change in the presentation format has
significant effects on memory for financial information. Our results also
suggest that the use of mental imagery to reinstate the original format may
significantly improve memory for financial data.
Mimicking
Behavior in Repurchase Decisions
Mike Cudd –
Harold E. Davis – Southeastern Louisiana University
Marcelo Eduardo –
Behavioral
biases associated with base rate neglect, anchoring, ambiguity aversion, and
robust control may foster an environment in which mimicking may influence
decision-making. This study tests for the presence of mimicking behavior in security
repurchase decisions. After controlling for variables reflecting financial
operating motives and mispricing associated with limits to arbitrage, results
show that debt-equity choices in repurchase events are significantly enhanced
by the occurrence of recent similar choices made by the firm's competitors.
Specifically, the probability of opting to repurchase equity (debt) is
positively associated with the size of the firm conducting the largest
percentage equity (debt) repurchase in the same industry in the prior year.
Moreover, the mimicking activity is observed for smaller-sized firms, but not
for larger firms. The findings are consistent with the premise that managers of
smaller firms are generally less skilled and experienced, and more prone to be
influenced by decision shortcuts such as mimicking the actions of peers.