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.
February 7, 2014 - Animal Spirits, Individual Investing
What individual investment behaviors are worst? In their January 2014 paper entitled “Which Investment Behaviors Really Matter for Individual Investors?”, Joachim Weber, Steffen Meyer, Benjamin Loos and Andreas Hackethal investigate relationships between the following ten tendencies of individual investors and portfolio performance:
- Portfolio turnover: unprogrammed trading volume scaled by portfolio value.
- Trade clustering: clustering of investor trades in time.
- Disposition effect: selling of winners and holding of losers.
- Leading turnover: trading before other investors (same security/same direction).
- Forecasting skill: systematically realizing excess returns on purchased securities.
- Trend following: buying funds with recent increases in value.
- Home bias: preference for German stocks or Germany-focused funds.
- Local bias: preference for stocks/funds with nearby headquarters.
- Lottery mentality: preference for stocks with low price and high idiosyncratic volatility/skewness.
- Under-diversification: holding only a few securities and/or highly correlated securities.
Using trading records, monthly position statements and demographics for 5,000 predominantly German individual investors who use a discount broker spanning January 1999 through November 2011, they find that: Keep Reading
July 30, 2013 - Animal Spirits
How much do equity investors leave on the table by focusing on categories of stocks (industry or style) and paying little attention to individual stocks? In her July 2013 paper entitled “Categorical Thinking in Portfolio Choice”, Swasti Gupta-Mukherjee investigates whether such simplifying categorical thinking is economically beneficial and what factors magnify or diminish it. She focuses on managers of U.S. equity mutual funds. She defines a Categorical Thinking Index (CTI) as relative emphasis on category-wide information relative to stock-specific information for making portfolio adjustments. She implements CTI based on two-digit SIC codes (broad industries) as categories. Each quarter, she measures CTI for a mutual fund based on the explanatory power of past industry returns for portfolio changes relative to the explanatory power of past individual stock returns for these changes. Using monthly returns, quarterly holdings and style (benchmark) representations for 2,812 U.S. equity mutual funds, along with associated industry and individual stock returns, during 1990 to 2011, she finds that: Keep Reading
March 22, 2013 - Animal Spirits
How do individuals perceive and position for Black Swans? In his March 2013 paper entitled “The Psychology of Tail Events: Progress and Challenges”, Nicholas Barberis employs a two-step framework to summarize recent research on the psychology of tail events. He first addresses belief about the probability of a tail event. He then covers actions/decisions based on this belief, with focus on the concept of probability weighting. Based on the available body of research, he finds that: Keep Reading
April 11, 2012 - Animal Spirits, Currency Trading, Individual Investing
How do relevant electronic social networks affect individual investing? In their March 2012 paper entitled “Facebook Finance: How Social Interaction Propagates Active Investing”, Rawley Heimer and David Simon investigate the propagation of active investing strategies within a Facebook-like social network of retail foreign exchange traders. Registered users of this free network (who must have a qualified foreign exchange broker account) have access to: (1) an indicator of the aggregate positions of the entire network in specific currency pairs; and, (2) a real-time view of the trading activity of mutually accepted “friends.” The network receives information about user trades instantly from qualified brokers. Using a complete record of activities within this network involving more than 5,500 foreign exchange traders, two million time-stamped trades and 140,000 messages and friendships mostly between February 2009 and December 2010, they find that: Keep Reading
January 13, 2012 - Animal Spirits, Individual Investing
How do individual investors adjust trading behaviors during bull and bear markets? Are any such adjustments advantageous? In their December 2011 paper entitled “Don’t Confuse Brains with a Bull Market: Attribution Bias, Market Condition, and Trading Behavior of Individual Investors”, Zhen Shi and Na Wang examine the trading behaviors of individual investors during different market conditions. They apply a regime switching model to the Chinese stock market to identify: a normal market during January 2005 through August 2006; a bull market during September 2006 through October 2007; and, a bear market during November 2007 through November 2008. They define excessiveness of trading based on two measures: (1) the performance of stocks bought versus that of stocks sold; and, (2) the relationship between portfolio turnover and performance. Using the trading records of 15,040 randomly selected individual Chinese investors during January 2005 through November 2008 (2,357,959 trades), they find that: Keep Reading
November 22, 2011 - Animal Spirits
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
October 20, 2011 - Animal Spirits
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
October 17, 2011 - Animal Spirits, Technical Trading
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
October 13, 2011 - Animal Spirits, Calendar Effects
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
October 13, 2011 - Animal Spirits, Fundamental Valuation
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