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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.

More Information is Better?

Is more investment information always better? Are there unintended consequences for individual investors/traders acquiring investment information? Specifically, do individual investors/traders systematically acquire information to support rational future decision-making, or do they focus on information that confirms (and builds overconfidence in) decisions already made? The following two recent studies examine these questions, with results as follows: Keep Reading

Bet Against Big Sympathy Moves?

Are investor actions well-calibrated when they punish or reward the stocks of all the companies in an industry based on the earliest earnings announcements among peer companies? In the December 2006 version of their paper entitled “Overreaction to Intra-Industry Information Transfers?”, Jacob Thomas and Frank Zhang test the efficiency of intra-industry information transfers by measuring whether the price responses of non-announcing firms to earlier peer group earnings announcements systematically relate to subsequent price responses when these same companies announce their own earnings a few days later. Using a sample of earnings announcement dates, stock returns and firm financial variables spanning 132 quarters over 1973-2005 (245,742 firm-quarter observations), they conclude that: Keep Reading

Selling Too Soon, and Holding on Hope?

Do investors really sell winners and hold losers, thereby helping the market beat them? In other words, are they reluctant to admit mistakes? In their November 2006 paper entitled “Is the Aggregate Investor Reluctant to Realize Losses? Evidence from Taiwan”, Brad Barber, Yi-Tsung Lee, Yu-Jane Liu and Terrance Odean investigate whether the average investor exhibits the disposition effect, the tendency to sell winning investments at a faster rate than losing investments. Using data for all trades on the Taiwan Stock Exchange during 1995-1999 (over one billion trades by nearly four million traders), they conclude that: Keep Reading

Do Mutual Funds That Practice Behavioral Finance Principles Outperform?

Do mutual funds that implement the tenets of behavioral finance, in defiance of the Efficient Market Hypothesis, outperform? Can they find and exploit systematic behavioral mispricings? In their August 2006 paper entitled “Behavioral Finance: Are the Disciples Profiting from the Doctrine?”, Colby Wright, Prithviraj Banerjee and Vaneesha Boney assess whether expert investors have validated the principles of behavioral finance by examining the aggregate performance of a group of mutual funds that practice them. Using equal-weighted data for 16 mutual funds most visibly associated with behavioral finance (see table below), they find that: Keep Reading

Stock Price Impacts of Management Changes

A reader observed and asked: “I read today that Peter Dolan, the CEO of Bristol-Myers Squibb (BMY), left the company…BMY was up nearly 4% at the open. How many other times have CEOs of unprofitable/unloved publicly traded companies gotten sacked and the share price rises on the news? Could this be a market inefficiency that market makers and traders (i.e., hedge funds) exploit to the chagrin of individual and institutional investors (mutual funds)? Does a publicly traded company with a stock price stagnant for years get a trader’s premium when a management change occurs?” Keep Reading

Spam Spasms: This Stock Ready to Explode!

Does touting of penny stocks via email spam work? If so, for whom? In their July 2006 paper entitled “Spam Works: Evidence from Stock Touts and Corresponding Market Activity”, Laura Frieder and Jonathan Zittrain assess the impact of unsolicited email touting on Pink Sheet stock prices. They also investigate who wins and who loses from such attempted manipulation. They construct their test sample from 75,415 unsolicited email messages touting a total of 307 mostly Pink Sheet stocks between January 2004 and July 2005, along with associated price and volume data for these stocks. They then create a control sample of randomly selected comparable Pink Sheet stocks. By comparing the test and control samples, they conclude that: Keep Reading

Jim Cramer’s Mad, Mad, Mad, Mad Market?

Can traders exploit irrational reactions to Jim Cramer’s stock recommendations by viewers of CNBC’s Mad Money? In their March 2006 paper entitled “Is the Market Mad? Evidence from Mad Money, Joseph Engelberg, Caroline Sasseville and Jared Williams measure the market’s reaction to Mr. Cramer’s buy recommendations. Using a sample of 246 initial recommendations made by Jim Cramer on Mad Money episodes between July 28, 2005 and October 14, 2005, as recorded by YourMoneyWatch.com, they conclude that: Keep Reading

Scared by Randomness?

How often should an investor/trader check the performance of their positions? Does it make a difference (psychologically) whether one checks frequently or infrequently? In their 2005 paper entitled “The Scaling Property of Randomness: The Impact of Reporting Frequency on The Perceived Performance of Investment Funds”, Nigel Finch, Guy Ford, Suresh Cuganesan and Tyrone Carlin use actual investment fund performance data to explore the likelihood that an investor would have viewed the performance as positive or negative based on sampling frequency. Applying prospect theory (a loss in wealth has a negative impact 2.25 times greater in magnitude than the positive impact of a gain in wealth) to data for four large Australian investment funds (see table below), they conclude that: Keep Reading

The Illusionary Markets Hypothesis?

Can influential traders actively profit from the psychological biases, the not fully rational decisions, of others? In the January 2005 update of their paper entitled “Illusionary Finance and Trading Behavior”, Malika Hamadi, Erick Rengifo and Diego Salzman introduce the concept of illusionary finance, based on the psychology of decision-making under time pressure and ambiguity, and analyze the creation and dissemination of illusions stock markets. They propose that: Keep Reading

The Hedge Fund Public Relations Game Plan?

Is this how a savvy hedge fund manager plays the game? First, get cozy with other fund managers, financial market research firms and the financial media. Then “orchestrate” the attention paid to a company in which the manager’s fund has taken a position? Here’s a picture, with some links to relevant allegations and news/commentary… Keep Reading

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