Volume
11, Number 1, 2010 Abstracts
© Copyright Taylor & Francis, LLC.
2010
Overly
Optimistic? Investor
Sophistication and the Role of Affective Reactions to Financial Information in
Investors' Stock Price Judgments
Lisa M. Victoravich -
This study investigates the difference in unsophisticated and sophisticated investors' affective reactions to a firm's positive earnings announcement. The study also investigates the variation in the stock price judgments of these two groups as a result of a differential reliance on the affective reaction. It contributes to the literature by providing a further understanding of the differential interpretation and reaction to financial data by investors with varying levels of knowledge and experience. In the experiment, participants were asked to review background financial information about a company, evaluate the company's earnings announcement and make stock price judgments. Results indicate that unsophisticated investors interpret a positive earnings announcement as more favorable than do sophisticated investors. The affective reaction to the earnings announcement was more influential on the stock price judgments of unsophisticated investors when compared to the stock price judgments made by sophisticated investors. This differential effect leads unsophisticated investors to make stock price judgments that exceed stock price judgments made by sophisticated investors. From a back to basics standpoint, these results suggest that investment-related knowledge and experience play a significant role in how individual investors react to and rely on basic financial information, which may be of interest to standard setters and regulators.
Effects of Visual Priming on
Improving Web Disclosure to Investors
Alex Wang -
Timothy Dowding - University of Connecticut-Stamford
This research used online experiments to examine how different types of visual priming affect less knowledgeable and knowledgeable online investors' processing and understanding of disclosure information. It also aimed at addressing what types of visual priming of online disclosure information are most effective at affecting less knowledgeable versus knowledgeable investors regarding their processing and understanding of disclosure information. The results revealed online investors perceived that categorical and semantic priming helped them process and understand the disclosure information better than feature priming. This result was confirmed when investors' knowledge levels did not change how knowledgeable and less knowledgeable investors perceived different types of visual priming. The results concluded that knowledge level did not interact with visual priming to influence investors' processing and understanding of disclosure information.
Investment Decision Making:
Do Experienced Decision Makers Fall Prey to the Paradox of Choice?
Thomas Kida -
Kimberly K. Moreno - Northeastern University
James F. Smith -
Psychology research suggests that decision makers fall prey to the paradox of choice phenomenon, where individuals are less likely to make a decision when faced with an extensive choice set than when faced with a limited choice set. This research may have important implications for investment decision makers in circumstances in which many investment options are available. However, the studies in psychology have typically examined the decisions of individuals who have no particular experience in the decision task. In this study, we examine whether individuals' investment decisions are affected by choice-set size (i.e., a limited vs. extensive choice set) and whether the effect is mitigated or changed for individuals who are more experienced with investment decisions. We find that the paradox of choice phenomenon is evident for participants who are less experienced with investing but not for more experienced participants. In fact, individuals who are more experienced with investment decisions were actually less likely to invest when faced with a limited choice set, contrary to the paradox of choice phenomenon. These findings suggest that the paradox of choice may not exist when individuals with investment experience make their decisions.
Financial Engineering and
Rationality: Experimental Evidence Based on the Monty Hall Problem
Brian Kluger - University
of Cincinnati
Daniel Friedman - University of California at Santa Cruz
Financial engineering often involves reconfiguring existing financial assets to create new financial products. This article investigates whether financial engineering can alter the environment so that irrational agents can quickly learn to be rational. We design two financial assets that embed the Monty Hall problem, a well-studied choice anomaly. Our experiment requires each subject to value one of these assets. Although these assets are equivalent in terms of standard choice theory, valuation experience with one of the assets lowers the subjects' cognitive error rates more than valuation experience with the other asset. We conclude that financial engineering can create learning opportunities and reduce cognitive errors.
The Availability Heuristic
and Investors' Reaction to Company-Specific Events
Doron Kliger -
Andrey Kudryavtsev -
Contemporary research documents various psychological aspects of economic decision making. The main goal of our study is to analyze the role of the availability heuristic (Tversky and Kahneman [1973, 1974]) in financial markets. The availability heuristic refers to people's tendency to determine the likelihood of an event according to the easiness of recalling similar instances and, thus, to overweight current information as opposed to processing all relevant information. We define and test two aspects of the availability heuristic, which we dub outcome and risk-availability. The former deals with the availability of positive and negative investment outcomes and the latter with the availability of financial risk. We test the availability effect on investors' reactions to analyst recommendation revisions. Employing daily market returns as a proxy for outcome availability, we find that positive stock price reactions to recommendation upgrades are stronger when accompanied by positive stock market index returns, and negative stock price reactions to recommendation downgrades are stronger when accompanied by negative stock market index returns. The magnitude of the outcome availability effect is negatively correlated with firms' market capitalization, and positively correlated with stock beta, as well as with historical return volatility. Regarding risk availability, we find that on days of substantial stock market moves, abnormal stock price reactions to upgrades are weaker, and abnormal stock price reactions to downgrades are stronger. Both availability effects remain significant even after controlling for additional company-specific and event-specific factors, including market capitalization, stock beta, historical volatility of stock returns, cumulative excess stock returns over one month preceding the recommendation revision, rating category before the revision, and number of categories changed in the revision.
Volume
11, Number 2, 2010 Abstracts
© Copyright Taylor & Francis, LLC.
2010
Comparing the Traits of Stock
Market Investors and Gamblers
Janice W. Jadlowa -
John C. Mowena -
The goal
of this research is to investigate to what extent gamblers and stock investors
share similar characteristics. Using survey data, a hierarchical model of
personality is employed to compare the traits of
gamblers and investors. The results reveal that gamblers and investors share
five trait characteristics and differ on three traits. Cluster analysis
supports the proposal that gamblers and investors can be
divided into four groups that differ across the personality traits. As a
result, divergent communication strategies should be used
to influence each group's propensity to invest and/or to gamble.
Psychological and Cultural
Factors in the Choice of Mortgage Products: A Behavioral Investigation
Masaki Mori - International University of Japan
Julian Diaz III - Georgia State University
Alan J. Ziobrowski - Georgia State University
Nico B. Rottke - European
Business School
Using data
from three countries that differ economically, culturally, and geographically,
this study examines the role of Prospect Theory's reflection effect, a
psychological factor, in combination with Uncertainty Avoidance (UA), a
cultural factor, on the choice of mortgage products. Experiments were conducted using business professionals in the
Improving Financial Decision
Making With Unconscious Thought: A Transcendent Model
Philip Yim Kwong Cheng -
This
article explains that a more rational and optimal approach to financial
decision making than is proposed by finance theories alone would be that
includes unconsciousness into the process. The total cognitive decision making
capacity of an individual is comprised of both a conscious component and an
unconscious component; and these two components are complementary and
compensatory to each another. A decision-making process that integrates these
two components would, therefore, first generally improve the quality of
decisions, and second reduce the unfavorable impact of behavioral biases (with
overconfidence, heuristics, etc as examples) on decision
making.
The Role of Company Affect in
Stock Investments: Towards Blind, Undemanding, Noncomparative
and Committed Love
Jaakko Aspara - Aalto University School of Economics (formerly
Henrikki Tikkanen -
This
conceptual article aims to increase our understanding of the influence that
individuals’ affective evaluations of companies have on their decisions to
invest in companies’ stocks. Based on various psychological literatures, the
authors explicate five different ways in which an individual investor's
positive affect toward a company may influence his decisions to buy/hold the
company's stock. These include a positive influence that company affect has on
optimism and overconfidence about the financial returns expected from the
company's stock, as well as a negative influence on the required financial
returns from the stock. The authors illustrate the influences with “love”
metaphors.
Payday Effects: An
Examination of Trader Behavior within Evaluation Periods
Ryan Garvey -
Fei Wu -
Security
firms typically link trader compensation to performance. We examine how this
influences traders to allocate their trading activities over time. Traders
employed at a
Detecting Anchoring in
Financial Markets
Jørgen Vitting Andersen - Institut Non Linéaire de Nice
Anchoring
is a term used in psychology to describe the common human tendency to rely too
heavily (anchor) on one piece of information when making decisions. Here a
trading algorithm inspired by biological motors, introduced by L. Gil [2007], is suggested as a testing ground for anchoring in financial
markets. An exact solution of the algorithm is presented
for arbitrary price distributions. Furthermore the
algorithm is extended to cover the case of a market neutral portfolio,
revealing additional evidence that anchoring is involved in the decision making
of market participants. The exposure of arbitrage possibilities created by
anchoring gives yet another illustration on the difficulty proving market
efficiency by only considering lower order correlations in past price time
series.
Volume
11, Number 3, 2010 Abstracts
© Copyright Taylor & Francis, LLC.
2010
An Experimental Examination
of Heuristic-Based Decision Making in a Financial Setting
Lucy F. Ackert -
Bryan K. Church - Georgia Tech
Paula A. Tkac - Federal Reserve Bank of Atlanta
This paper
reports the results of an experiment designed to examine information
acquisition and evaluation in a financial setting, predicting mutual fund
performance. We compare behavior across four distinct subject pools to provide
insight into how training, knowledge, and experience affect decision
making. We manipulate the decision environment by first increasing the
time constraint and then increasing the decision cost. Although we find
differences in behavior across subject pools, subjects’ performance is similar.
Outcomes are similar across the distinct subject pools, despite significant
differences in financial education.
Investor Extrapolation and
Expected Returns
Wen He -
Jianfeng Shen -
This paper
takes a new approach to examine whether investors extrapolate from past returns
to form expectations about future stock returns. Unlike prior research that
relies on experiments or surveys to derive investors’ expectations, we estimate
expected returns directly from stock prices, the book value of equity, and
analyst earnings forecasts. We find that the expected returns are positively related to both past market returns and past
stock returns. However, investors’ expectations seem to be overoptimistic (overpessimistic) for stocks that had extremely high (low)
returns in the previous year. Furthermore, we find that investors’ expectations
about future earnings growth rates are also positively related to past growth
rates. The results remain robust after we control for analyst optimism and
measures of risk. Taken together, our results are consistent with the findings
that investors extrapolate from past stock returns and past earnings growth
rates.
Mitigating Investor
Risk-Seeking Behavior in a Down Real Estate Market
Michael J. Seiler -
Vicky L. Seiler -
Using an
extension of the prospect theory known as false reference points, this study
examines the behavior of real estate investors after experiencing a loss. The
results confirm our central hypothesis that when investors attempt to avoid the
pain of regret by changing the lens through which they view losses, they become
more likely to hold onto bad investments. This unwillingness to sell bad
investments in the short run causes investors to be more likely to experience
heightened levels of unavoidable regret in the long run.
The results hold across demographic characteristics but are
slightly more pronounced for men and international investors,
specifically those from
The Influence of Affective
Reactions on Investment Decisions
Enrico Rubaltelli - University of Padova
Giacomo Pasini - Venice
University and Netspar
Rino Rumiati - University
of Padova
Robert A. Olsen - Decision Research
Paul Slovic - Decision Research and University of
Oregon
The
present research aims to show how investors’ affective reactions toward a fund
influence their decision to sell the investment. Participants were presented with either a socially responsible or a
traditional fund. After completing a mental images task, participants were asked to state the price at which they were willing to
sell the fund and their confidence in future positive performance. Participants
were willing to sell the fund at different prices depending on their affective
reactions. The affective reactions also influenced participants’ confidence.
Furthermore, we found that the socially responsible fund induced a more
positive reaction than the ordinary fund.
Risk Perception of Employees
with Respect to Equity Shares
Ranjit Singh - Assam
University (A Central University)
Amalesh Bhowal - Assam University (A Central University)
Risk
perception is the subjective judgment that people make about the
characteristics and severity of a risk. Risk perception plays a very important
role in equity share investment decision of an
investor. The objective of the present paper is to find out the level of risk
perception of the employees with respect to the different classes of equity
investment. It is found that the risk perception of
the employees for the shares of their own company as well as the indirect
investment in equity shares is relatively lower than the risk perception for
the shares of the companies other than their own companies. It was also found
that there is lower degree of correlation among the risk perception for the
shares of their own company, shares of other company and indirect investment in
equity shares which means that risk perception with
respect to one share is not influencing the risk perception for other shares.
Volume
11, Number 4, 2010 Abstracts
© Copyright Taylor & Francis, LLC.
2010
Using an Eye Tracker to
Examine Behavioral Biases in Investment Tasks: An Experimental Study
Tal Shavit - The
Cinzia Giorgetta -
Yaniv Shani -
Fabio Ferlazzo -
Contrary to the premise of rational models, which suggests that
investors’ aggregate portfolios are the appropriate informational asset for
evaluating a file performance, we find, using an eye tracker, that investors
spend more time looking at performances of an individual asset than at the
performances of the overall aggregated portfolio and at the net value change
more than the assets’ final value. We also find that investors look at the monetary value
change longer than at change in percentages. Specifically, participants look
longer at the value change of gaining assets than at the value change of losing
assets. We propose the possibility that investors are not only engaged in
judgment when evaluating their portfolio (leading to loss aversion and mental
accounting) but may also be predisposed to looking for
reassuring elements within it. Thus, it may be that humans use mental
accounting by nature and not necessarily by judgment.
What Is Wrong with this
Picture? A Problem with Comparative Return Plots on Finance Websites and a Bias
Against Income-Generating Assets
Pankaj Agrrawal - University
of Maine
Richard Borgman - University of Maine
This paper
brings to light and discusses a systemic issue in the calculation and display
of relative return information as currently seen on some of the most prominent
finance websites; income-generating events such as dividends and interest are
not included in relative return calculations and all comparative return
graphics. The resulting ranking of the securities, based on such incomplete
returns, is essentially meaningless from a total return perspective, yet they are being served to millions of investors every day. This
could lead to the formation of a possible availability heuristic and an optical
bias against fixed-income and other income generating assets. This problem has
gone unnoticed for many years with no discussion of the topic either in the academic
or practitioner press. The ready availability of such unclear or inaccurate
information from sources generally perceived to be credible can,
in this age of do-it-yourself portfolio management, have serious and
damaging financial consequences to the unsuspecting investor. The paper also
shows the effect of this return differential on the calculation of the asset
correlation matrices and the subsequent effect on the resulting asset-weight
vectors that are used to generate Markowitz style
mean-variance portfolios. The visual discrepancies are then
supported by the application of the Gibbons, Ross and Shanken [1989] W-test for portfolio efficiency. The
authors’ proposed correction, based on elementary finance, fixes the problem.
A More Predictive Index of
Market Sentiment
Todd Feldman -
Recently,
finance literature has turned to non-economic factors such as investor
sentiment as possible determinants of asset prices. Using mutual fund data, I
calculate a new sentiment measure, a perceived loss index. The advantage of the
loss index is that it can determine perceived risk for different categories of
equities, including market capitalization, style and sector. Results provide
evidence that the perceived loss index outperforms all other sentiment and
systematic risk measures in predicting future medium run returns, especially
for one- and two-year horizons. This evidence pertains not just to broad market returns but also to capitalization-style and
sector specific indice returns as well. In addition,
I provide evidence that the loss index can be used as
a quantitative measure to detect bubbles and financial crises in financial
markets.
Does Mr. Market Suffer from
Bipolar Disorder?
James H. B. Cheung - The
Benjamin
Graham, the father of value investing, argued that the stock market (which he
coined “Mr. Market”) suffers from a mood disorder known as bipolar disorder
(formerly called manic depression). Warren Buffet and John Maynard Keynes have
also endorsed the idea that market psychology has an influential role to play
in the stock market. According to Graham, the mood of Mr. Market is unstable
and frequently oscillates between mania and depression. To engage a good
understanding of mood disorders, the Diagnostic and Statistical Manual of
Mental Disorders (DSM), published by the American Psychiatric Association, is consulted. Various versions of mood disorder are discussed. Based on observation, it is plausible that
the stock market indeed suffers from bipolar disorder. The market mood model
(MMM) is developed to model the dynamics of market
mood. It is divided into six market phases, and each
phase has its own set of market characteristics. There is a critical point for
each phase and, once breached, the market moves on to the next phase. The
application of the MMM utilizes three market bubbles as illustration: 1990
Japanese bubble, 2000 Internet bubble and 2007 subprime mortgage crisis. The
final section examines the option of adopting a stable official interest rate
policy to stabilize asset prices.
Prior Perceptions,
Personality Characteristics and Portfolio Preferences among Fund Managers: An
Experimental Analysis
This
article examines the question of cross-domain risk-taking behavior. That is,
will risky behavior in one arena translate into risky behavior in another
arena? The specific area of interest concerns lifestyle risk taking and
financial risk-taking behavior. We utilize several psychological tests to test
the respondents for the following biases: familiarity, optimism, unique
invulnerability, sensation-seeking and impulsivity.
The methodology utilizes tests that have not been employed
in other studies. The respondents were given these
tests plus a portfolio preference survey to test for effects on investing
decisions. Two cohorts of student-managed investment fund managers were surveyed. These were predominantly twenty-something
males who were college seniors. These subjects were chosen
for two reasons: they represented a risk-taking population in general and they
were sophisticated investors. We found no discernible biases present in their
survey results. We also tested the mean responses to the portfolio management
survey across the two cohorts, which occurred around the subprime market crash.
Interestingly, the mean responses of the portfolio choice variables were not
statistically different.