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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.

What Puts Brits in the Mood (for Buying or Selling Stocks)?

Do macroenvironmental variables affect stock returns by influencing aggregate investor mood? In their February 2007 paper entitled “Mood and Uk Equity Pricing”, Michael Dowling and Brian Lucey investigate the relationship between between a variety of mood variables (temperature, precipitation, wind speed, geomagnetic storms, Seasonal Affective Disorder, Daylight Savings Time Changes and lunar phases) and returns for a broad UK stock index and a small-capitalization UK stock index. Using daily data for the period 12/12/04-11/10/04, they conclude that: Keep Reading

Bear Claus

As the esteemed, erudite chorus of the downside constantly reminds us, Bear Claus: Keep Reading

A Bear’s Perspective on a Bull Market?

When the market trend challenges their beliefs, what do we hear from market “experts?” Keep Reading

Why Rational Asset Pricing Models Don’t Work Well

Proponents of rational markets build on a common-sense foundation of reward for risk, with price variability (beta) as the fundamental risk. Since this single source of risk does not predict asset prices very well, rationalists have empirically appended to their models other sources of risk (proxied by size, value and momentum factors) in search of better predictions. Proponents of behavioral finance counter with innate cognitive and emotional biases (irrationality) as causes of rational model failures. Is there a way to prove one of these two views more correct? Should rationalists look for additional risk factors? Does some third perspective offer insight? In their January 2007 preliminary paper entitled “Failure of Asset Pricing Models: Transaction Cost, Irrationality, or Missing Factors” Joon Chae and Cheol-Won Yang tackle these questions. Using monthly stock return data for 700 Korean firms over the period December 1997 to November 2004 (84 months), along with associated measures for both potential degree of trader rationality (sophistication) and transaction costs, they conclude that: Keep Reading

A Sign of All Times…

…is fear as a sales pitch. Keep Reading

“Media”ting Your Portfolio?

What is the role of journalists in the stock selection process? Are they experts, signal amplifiers or noise amplifiers? Is their collective view short-term or long-term? In two recent papers, Alexander Kerl and Andreas Walter examine the nature and value of the stock filtering role of journalists writing for German personal finance magazines (such as Effecten-Spiegel and Börse Online). Keep Reading

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

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