Chapter 9: Introduction to Behavioral Finance

the Odean paper that shows that tradaing by investors with discount brokerage account is excessive uses

10,000 accounts from Jan. 1987 to Dec. 1993; 163,000 records

modern finance was developed in

1952 (with Harry Markowitz)

empirical puzzles (things that are not explained by the canonical model) came about in

1981

behavior finance became more organized and emerged as a field in

1995

individuals who do worse than a money throwing darts to pick stocks

25% of the market

even though indexing is growing in popularity, only about ___ of equity in the mutual fund industry is held in indexed funds. This may be a sign that investors and managers ____.

25%; overestimate their ability

the 1999 Odean paper uses the _____ model to calculate excess returns

3-factor fama and french

men trade ___ more than women, hurting their ___ percentage points per year

45%, 2.65

the ratio of the price of Royal Dutch to the price of shell should be

6.2

___ model in modern finance developed by Ross 1976

Arbitrage pricing theory

paper that tested overcondifence leading to excesive trading using gender as a proxy for confidence

Barber, Odean 2001

All that glitters: the effect of attention and news on the buying behavior of individual and institutional investors - individual investors buy more attention grabbing stocks - stocks with high abnormal trading volume and with extreme one day returns

Barber, Odean 2008

What drives the disposition effect? - the annual gain/loss model fails to predict disposition effect - prospect theory not correct

Barbereis, xiong 2009

Stocks as Lotteries: the implications of Probability weighting for security prices - we perceive smaller objective probabilities higher - greater objective probabilities have lower perceived probabilities

Barberis and Huang 2008

the first paper to document the overconfidence bias was

Barder and Odean 2001

nominal price illusion - investors suffer from a nominal price illusion in which they overestimate the room to grow for low-priced stocks relative to high priced stocks - investor expectations for future skewness increase on days that a stock splits to a lower nominal price

Birru, Wang 2015

___ model in modern finance developed by Treynor 1961, and Sharpe 1964

CAPM

Looking for someone to blame: delegation, cognitive dissonance and the disposition effect - investors avoid realizing losses becuase they dislike admitting mistakes - delegation reverses this effect by allowing the investor to blame the manager instead - disposition effect only applies to non-delegated assets

Chang, solomon, westernfield, 2016

people blame themselves more for unconventional choices that turn out badly; they avoid regret by making conventional decisions

DeBondt, Thaler 1987

paper to show evidence of familiarity effect and that lack of diversification does not lead to superior returns

Doskeland and Hvide 2011

Do individual investors have asymmetric information based on work experience? - individual investors hold 11% of portfolio within their 2 digit industry - all estimates of abnormal returns are negative, and stat sig (risk does not match reward)

Doskeland, Hvide, 2011

___ model in modern finance developed by Fama 1970

EMH

The causal impact of media in financial markets - compare behaviors of investors with same info but different media coverage - front page positioning in Bloomberg - induces 280% higher trading volumes - induces 180% large price changes within 10 minutes of publication - creates exogenous, artificial variation in attention (not due to real difference)

Engelberg, parsons 2011

peer pressure: social interaction and the disposition effect - social interaction contributes to some trader's disposition effect - myForexBook - exposure to social network doubles susceptibility to the disposition effect on trader's market orders

Helmer 2016

Contagious speculation and a cure for cancer: a nonevent that made stock prices soar - showed rise in stock prices as a reflection of information that had already been published 5 months earlier (NY times vs. Nature Magazine)

Huberman, Regev, 2001

Returns to buying winners and selling losers: implications for stock market efficiency - 3-12 month holding periods show momentum

Jagadeesh, Titman 1993

returns to buying winners and selling losers: implications for stock market efficiency - momentum factor for 3- to 12- month holding periods

Jagadeesh, Titman 1993

Individual investor trading and stock returns - individuals buy stocks following declines in the previous months and sell following price increases

Kaniel, Saar, Titman 2008

Who gambles in the stock market? - individual investors prefer lottery-type stocks - higher volatility, positive skewed returns, low stock price - 1.25% of the market - should be 1%, but individual investors hold as about 4% of portfolio - institutional investors hold less than 1% of portfolio here -have negative alphas, are overpriced; lower mean return

Kumar 2009

can the market ass and subtract? miss-pricing in tech stock carve outs - palm carve out and IPO - the price of 3Com should be at least greater than 1.5 price of palm

Lamont, Thaler, 2003

the equity premium, a puzzle - cannot be justified except by extremely high, unrealistic risk aversion level

Mehra, Prescott 1985

The first paper to show that the average individual investor does worse than a money throwing darts at the stock section of a newspaper. - do investors trade too much - trading by investors with discount brokerage accounts is excessive - average return on stocks sold is greater than average return on stocks bought

Odean, 1999

examples of clearly wrong prices - Royal Dutch/Shell

Rosenthal and Young, 1990

- affect bias (feelings based on corporate social or environmental responsibility) stocks of fortunes: most admired companies have higher prices relative to underlying profitability

Statman, Fisher, Anginer 2008

just how much do individual investors lose by trading - 2.2% of Taiwan's GDP - 2,8% of total personal income - as much as total private expenditure on clothing and footwear in Taiwan

barber, Lee, Lui, Odean 2009

recurrent behavior that leads to losses

behavioral bias

modern finance is also called the

canonical model

___ model in modern finance developed by Lucas 1978

consumption based asset pricing

the neglecting information on stock prices leads to ___ strategies employed by household

contrarian

individual investors are _____. They buy when the price falls and sell when the price goes up

contrarians

marriage leads to a ___ in turnover rates when compared to single men and women (single man = 6.7 -> 6.3) (single women = 4.6 -> 4.8)

convergence

the tendency of investors to hold losing investments too long and sell winning investments too soon

disposition effect

Odean 1998 Change, Solomon, Westernfield 2016 Heimer 2016

disposition effect; investors are reluctant to sell loser gains and admit loss

overconfidence bias (I am better than I actually am, the info I get is more precise than it actually is) leads to ___ ___ and a lack of ___

excess trading; diversification

decisions are affected by how choices are posed - risk averse in terms of gains, but risk-seeking in terms of loss

framing bias

which proxy measure did Barber and Odean 2001 use for overconfidence?

gender

foregin momentum vs. domestic contrarian

ginblatt, keloharju 2000

equity portfolio diversification - US individual investors hold under-diversified portfolios - due to overconfidence, trend following behavior, and local bias - about 28% of portfolios have only 1 stock - more than 50% of portfolios have 1, 2, or 3, stocks - 20 stocks provides sufficient diversification - degree of under-diversification is higher among retirement portfolios

goetzman, kumar 2008

sensation seeking, overconfidence and trading activity - disentangle sensation seeking and over confidence - males are more prone to sensation seeking behavior - uses speeding tickets, self confidence on test, ability score - turnover seems to be the proxy for sensation seeking

grinblatt, keloharju, 2009

the dollar value of a portfolio for men is ___ than for women, although the medians are similar

higher

hypothesis 1 of the canonical model

investors have rational beliefs (perfect information, update using the Bayes rule)

hypothesis 2 of the canonical model

investors maximize expected utility (have simple preferences and utility functions like the CRAA)

men show much higher turnover in value of their portfolio (6.4% vs. 4,4%)

men trade more

what are the hypotheses in the barber, odean 2001 paper?

men trade more than women, by trading more men hurt their performance more

form of framing in which people segregate certain decisions; momentum stocks and house money effect explained

mental accounting

foreign investors tend to be ___ investors, buying past winning stocks and selling past losers. Domestic investors, particularly households tend to be ___

momentum; contrarians

the first paper to look at the disposition effect (investors demonstrate a strong preference for realizing winners rather than losers) - investors are twice as likely to realize gains than losses - even in December with tax benefits for losses, the ratio is close to 1

odean, 1998

what are the 7 behavioral biases

overconfidence, disposition effect, local bias and familiarity; nominal price illusion; neglect information in prices; preference for lottery like stocks; preference for attention grabbing stocks

what are the assumptions of the canonical model (3)?

rational beliefs, maximize expected utility; no frictions

conventional finance theory assumes investors are ___ and behavioral finance assumes investors are ____

rational; irrational

in the modern finance canoncial model, investors are ____; when they are not arbitrageurs act and quickly correct ___ ___

rational; irrational behavior

a concave curve (gain portion of the utility curve) demonstrates a __ ___ investor

risk averse

sensation seeking is distinct from the magnitude or sign of the

risk aversion parameter

a convex curve (loss portion of the utility curve) demonstrates a ___ ____

risk loving disposition

variable used to capture changing investor expectations of asymmetry in return distributions

risk-neutral skewness

individual investors and local bias - portfolios of local holdings do not generate abnormal performances (alpha = 0) - do individuals have relevant info about local stocks - on average, an individual invests about 30% in local stocks - on average market invests about 12% in local stocks - this is a poor hedging strategy - no significant difference in return on local and remote stocks

seasholes and zhu 2016

All of the following are consistent with feelings of regret and the disposition effect, excepts

selling losers quickly

the first paper to show that stock prices move too much to be justified by subsequent changes in dividends?

shiler 1981

Do stock prices move too much to be justified by changes in dividends? - stock price are much more volatile than the ex post rational price (found using PV of dividend calculations in perpetuity) - influential in showing that MF does not explain data well

shiller, 1981

hypothesis 3 of the canonical model

there are no frictions in the market (informational costs or limits to arbitrage)

behavioral biases are recurrent in

time series and cross section

does the stock market overreact? - violation of bayes rule - weak form market inefficiencies shown - portfolios formed 36 months after, conditional upon excess return behavior prior to portfolio formation - winners underperform and losers overperform

werner, bondt, thaler, 1985