Animal Spirits

Are investors and traders cats, rationally and independently sniffing out returns? Or are they cows, flowing with a herd that must know something? These blog entries relate to behavioral finance, the study of the animal spirits of investing and trading.

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Doom and the Stock Market

Is proximity to doom good or bad for the stock market? To measure proximity to doom, we use the “Doomsday Clock” “Minutes-to-Midnight” metric, revised occasionally via the Bulletin of the Atomic Scientists, which “conveys how close humanity is to catastrophic destruction–the figurative midnight–and monitors the means humankind could use to obliterate itself. First and foremost, these include nuclear weapons, but they also encompass climate-changing technologies and new developments in the life sciences that could inflict irrevocable harm.” We assume the atomic scientists issue changes in proximity to doom near the beginning of indicated years. Using the timeline for the Doomsday Clock since inception and contemporaneous annual returns for the Dow Jones Industrial Average (DJIA) during 1947 through 2012 (21 doom proximity judgments), we find that: Keep Reading

Quarterly Earnings Announcement Reversals

Are firm earnings announcements bound to confound stock traders? In their November 2011 paper entitled “Systematic Noise and News-Driven Return Reversals”, Eric So and Sean Wang examine trading behavior around quarterly earnings announcements. They define pre-announcement return as the market-adjusted return over a three-day window from five days before through three days before earnings announcement date. Each quarter, they sort stocks into quintiles by pre-announcement return, with quintile break points from the distribution of the prior calendar quarter to avoid look-ahead bias. They adjust announcement date one trading day forward for announcements after the market close. Using 183,228 earnings announcement dates and contemporaneous daily stock and stock market returns during 1990 through 2009, they find that: Keep Reading

Animal Spirits Neuroscience

Is science making progress in deconstructing the animal spirits at play in financial markets? In the October 2011 draft of his chapter entitled “Fear, Greed, and Financial Crises: A Cognitive Neurosciences Perspective”, Andrew Lo explores the neuroscientific underpinnings of those human behaviors most relevant to financial system risk. Citing a range of uncontrolled (opportunistic) and controlled experiments on brain operations, he finds that: Keep Reading

Refined Short-term Reversal Strategies

Does short-term (one-month) stock return reversal persist? If so, is there a best way to refine and exploit it? In their March 2012 paper entitled “Short-Term Return Reversal: the Long and the Short of It”, Zhi Da, Qianqiu Liu and Ernst Schaumburg decompose the total short-term reversal into an across-industry component (long prior-month loser industries and short prior-month winner industries) and a within- industry component (long prior-month loser and short prior-month winner stocks within each industry). They then further decompose the within-industry return reversal into three components related to: (1) variation in three-factor (market, size, book-to-market) expected stock returns; (2) underreaction/overreaction to within-industry cash flow news (relative to analyst forecasts); and, (3) a residual component attributable to discount rate news/liquidity shocks. Using monthly data for a broad sample of relatively large and liquid stocks accounting for about 75% of U.S. equity market capitalization over the period January 1982 through March 2009, they conclude that: Keep Reading

Lunar Cycle and Stock Returns

Does the lunar cycle affect the behavior of investors/traders, and thereby influence stock returns? In the August 2001 version of their paper entitled “Lunar Cycle Effects in Stock Returns” Ilia Dichev and Troy Janes conclude that: “returns in the 15 days around new moon dates are about double the returns in the 15 days around full moon dates. This pattern of returns is pervasive; we find it for all major U.S. stock indexes over the last 100 years and for nearly all major stock indexes of 24 other countries over the last 30 years.” To refine this conclusion and test some recent data, we examine U.S. stock returns during intervals relative to the dates of new and full moons since 1990. When the date of a new or full moon falls on a non-trading day, we assign it to the nearest trading day. Using dates for new and full moons for January 1990 through September 2011 as listed by the U.S. Naval Observatory (269 full and 269 new moons) and contemporaneous daily closing prices for the S&P 500 Index, we find that: Keep Reading

Dividend Month Premium

Do investors focus on dividends, thereby elevating associated stock prices as ex-dividend date approaches? In the September 2011 draft of their paper entitled “The Dividend Month Premium”, Samuel Hartzmark and David Solomon examine the price behavior of stocks with scheduled quarterly, semiannual and annual dividends during the expected dividend month and around expected ex-dividend dates. Using daily and monthly price and cash dividend data for a broad sample of U.S. stocks during January 1927 through December 2009, along with widely used risk adjustment factors, they find that: Keep Reading

Announcement Tone and Short-term Reaction to Earnings News

Does the semantic tone of an earnings announcement, as measured independently of the level of earnings surprise, affect stock price reaction. In his September 2011 paper entitled “Short-term Reactions to News Announcements”, Michal Dzielinski investigates the effect of the tone (positive, neutral or negative) of the words in earnings announcements and other company news on stock prices from two days before to ten days after release. He averages news tone for each stock by day, with news released before (after) the market close counting as current-day (next-day) news. Using daily return data and over six million automatic, real-time Thomson Reuters news sentiment (tone) measurements (including those for over 68,000 earnings announcements) for 4,750 U.S. stocks during 2003 through 2010, he finds that: Keep Reading

Stock Spikes Around CEO Interviews

Do investors in aggregate respond to “staged” CEO visibility? In the August 2011 update of their paper entitled “CEO Interviews on CNBC”, Felix Meschke and Andy Kim investigate whether planned interviews with CEOs on financial television systematically affect associated stock prices over the days before and after the interview. The authors focus on the interval from two trading days before through ten trading days after interview date. Using daily stock price and trading data associated with 6,937 CEO interviews broadcast on CNBC during June 1997 through December 2006 (9.5 years), along with contemporaneous CNBC viewership levels and corporate news, they find that: Keep Reading

Overview of Research on Individual Investors

What does the body of academic research say about the stock trading behaviors and outcomes for individual investors? In their June 2011 paper entitled “The Behavior of Individual”, Brad Barber and Terrance Odean survey four areas of empirical research on the behavior of individual investors trading individual stocks: (1) performance, (2) the disposition effect, (3) buying behavior and (4) diversification. Using the findings of many studies performed over the last three decades, they conclude that: Keep Reading

A Few Notes on Investing and the Irrational Mind

In his 2011 book Investing and the Irrational Mind: Rethink Risk, Outwit Optimism, and Seize Opportunities Others Miss, author Robert Koppel posits that investing has “less to do with the science of computation and more to do the art of managing one’s outlook, emotions, and consciousness.” He seeks to explain “how to overcome debilitating emotions, irrational biases, and investment fallacies and arrive at an understanding of overall market risk through an approach that identifies, assesses, and controls losses. …how we can master our irrational minds to gain the skills necessary to control our financial decisions.” Some notable points from the book are: Keep Reading

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