Volume 11

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 - University of Denver

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 - University of Connecticut-Stamford
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 - University of Massachusetts at Amherst
Kimberly K. Moreno - Northeastern University
James F. Smith - University of Massachusetts at Amherst

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 - University of Haifa
Andrey Kudryavtsev - University of Haifa

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 - Oklahoma State University
John C. Mowena - Oklahoma State University

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 United States, Germany, and Japan. The results suggest that risk-averse people tend to become more risk seeking, leaning more toward adjustable-rate mortgages (ARMs) when choosing a mortgage type, and that this psychological effect may underlie the mortgage choices of people who tend to choose ARMs, even across countries with different cultures.

Improving Financial Decision Making With Unconscious Thought: A Transcendent Model
Philip Yim Kwong Cheng - Australian Catholic University

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 Helsinki School of Economics HSE)
Henrikki Tikkanen - Aalto University School of Economics (formerly Helsinki School of Economics HSE)

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 - Duquesne University
Fei Wu - Jiangxi University of Finance and Economics

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 U.S. broker-dealer trade more actively on their last day of trading in a monthly evaluation period. Self-employed traders, who trade on their own behalf, do not exhibit this behavior. Employed traders intensify their trading at the very last moment to increase their ensuing compensation payout. We label this behavior the payday effect. The payday effect is not driven by a change in market trading conditions, or due to traders possessing more information. Instead, we show that this behavior is highly dependent upon a trader's cumulative income within the performance evaluation period.

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 - Kennesaw State University
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 - University of New South Wales
Jianfeng Shen - University of New South Wales

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 - Old Dominion University
Vicky L. Seiler - Johns Hopkins University

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 Asia.

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.

Using an Eye Tracker to Examine Behavioral Biases in Investment Tasks: An Experimental Study
Tal Shavit - The College of Management
Cinzia Giorgetta - University of Rome
Yaniv Shani - Tel-Aviv University
Fabio Ferlazzo - University of Rome

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 - San Francisco State University

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 University of Queensland

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
Lawrence J. Belcher - George Investments Institute, Stetson University

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.