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.
February 19, 2008 - Animal Spirits, Size Effect, Value Premium
Do investors price stocks based mostly on rational analysis or feelings? In their February 2008 paper entitled “Affect in a Behavioral Asset Pricing Model”, Meir Statman, Kenneth Fisher and Deniz Anginer use survey results to investigate both the objective and subjective (perceived) connections between risk and return. Using results of: (1) the 1982-2006 annual Fortune surveys of senior executives, directors and security analysts regarding the long-term investment value of companies; and (2) May and July 2007 surveys of high-net worth clients of a large investment firm, they conclude that: Keep Reading
February 8, 2008 - Animal Spirits
Do investors love their losers more than their winners? In their January 2007 paper entitled “The Effect of Prior Beliefs and Preferences on Information Processing in an Investment Experiment”, Jeremy Ko and Oliver Hansch use a stock picking simulation to measure the bias investors exhibit when processing new information about stocks they have selected. Each iteration of the simulation involves picking one of two similar stocks that will outperform during the coming week. Using results from simulations involving 99 total participants in 2003 and 2004, they conclude that: Keep Reading
December 7, 2007 - Animal Spirits, Equity Premium
Is risk premium variation principally a consequence of changes in objective business conditions, or is some human dynamic important? In their November 2007 paper entitled “Diverse Beliefs and Time Variability of Risk Premia”, Mordecai Kurz and Maurizio Motolese examine the effect of diverse but individually rational market beliefs on risk premiums. They define belief as a variable independent of all observed fundamentals, with its own dynamic that reflects changes in the distribution of investor risk perceptions. Using monthly interest rate forecasts compiled by Blue Chip Financial Forecasts since 1983 to measure market beliefs and associated actual interest rate data, they conclude that: Keep Reading
October 19, 2007 - Animal Spirits
Do round numbers have a special meaning for stock traders? If so, is there a way to exploit any associated trading tendencies? In their 2007 paper entitled “Round Numbers and Security Returns”, Edward Johnson, Nicole Johnson and Devin Shanthikumar examine returns (calculated based on midpoints of subsequent closing bid and ask prices) after closing prices that are just above or just below round numbers. Using closing price and closing bid-ask data and firm characteristics for a broad sample of U.S. stocks during the post-decimalization period of 5/01-12/06, they conclude that: Keep Reading
October 1, 2007 - Animal Spirits, Individual Gurus, Size Effect
Are Jim Cramer’s stock recommendations on CNBC’s Mad Money most meaningful for small-capitalization stocks, for which prices are most susceptible to influence by the concerted behavior of a group of individual investors? In their September 2007 working paper entitled “The Performance and Impact of Stock Picks Mentioned on Mad Money“, Bryan Lim and Joao Rosario evaluate the show’s ability to move markets over the short term and to forecast winners and losers over the long term. Using a sample of 10,589 Mad Money buy and sell recommendations representing 2,074 distinct firms, either initiated by Jim Cramer or provided by him in response to callers, from shows aired between June 28, 2005 and December 22, 2006, they conclude that: Keep Reading
September 19, 2007 - Animal Spirits
Do strong emotions generally help or hinder trading? How do outperforming traders handle their emotions? In the 2007 paper entitled “Being Emotional during Decision making – Good or Bad? An Empirical Investigation”, flagged by reader Dennis Page, Myeong-Gu Seo and Lisa Feldman Barrett investigate the role of emotions in stock trading via a simulation involving 101 traders recruited from investment clubs and paid $100 to $1,000 based on performance during the simulation. Using the self-reported emotional states of these traders during simulated buy-sell decisions on 12 available stocks each day for 20 consecutive trading days, they conclude that: Keep Reading
September 5, 2007 - Animal Spirits
Has disintermediation of trading, enabled by the Internet, changed the level of risk that individual investors/traders routinely assume? In his 2005 paper entitled “Where the Action is: Internet Stock Trading as Edgework”, Detlev Zwick argues that the transition of stock trading from pre-Internet communication modes (telephone, fax and in-person) to the computer screen creates new types of individual experiences and practices that existing economic and finance theories do not predict or understand. Using in-depth oral interviews extended by email follow-ups with 25 experienced online investors in Germany, Denmark, and the United States during 2000-2002, he concludes that: Keep Reading
August 22, 2007 - Animal Spirits
During a crisis, do investors overreact in reallocating funds from risky assets (stocks) to safe 13-week Treasury bills (T-bill), with stock prices and T-bill yields consequently falling together? Once the crisis abates, do investors cthen orrect their overreaction by moving funds back from T-bills to stocks, with stock prices and T-bill yields then rising together? To test this model of investor behavior, we examine relationships between overall stock market returns and T-bill yield changes during and after dramatic declines in the T-bill yield for past and future intervals of 10, 21 and 63 trading days. Using daily closes for the S&P 500 index and T-bill yield from 1/4/60 through 8/20/07 (11,864 days when both traded), we find that: Keep Reading
July 25, 2007 - Animal Spirits, Individual Investing
Do individuals understand their actual aggregate investing/trading performance? In their July 2007 paper entitled “Why Inexperienced Investors Do Not Learn: They Don’t Know Their Past Portfolio Performance”, Markus Glaser and Martin Weber measure whether individual investors can correctly estimate personal absolute and relative stock portfolio performance. Using the responses of 215 online investors to a 2001 internet survey and actual portfolio returns for these investors during 1997-2000 as calculated from their holdings during that period, they find that: Keep Reading
July 9, 2007 - Animal Spirits, Value Premium
Are multi-year runs of bad (good) performance by individual stocks indicative of future returns? In other words, does the long-run behavior of stocks on average persist, reverse or fade to random? In their October 2006 paper entitled “Return Reversal in UK Shares”, Glen Arnold and Rose Baker examine the magnitude, persistence and source of reversals for UK stock returns. Using monthly total return and associated fundamentals data for stocks listed on the London Stock Exchange over the prior five calendar years during 1975-2002 (48 years), they find that: Keep Reading