Volume 12

Volume 12, Number 1, 2011 Abstracts
© Copyright Taylor & Francis, LLC. 2011

Are Multiple Analyst Earnings Forecasts Better Than the Single Forecast?
Ning Du - DePaul University
John E. McEnroe - DePaul University

This study investigates the impact of multiple information sources. Specifically, we examine whether single and multiple earnings forecasts may differentially influence investors’ expectations. We focus on two main aspects of investors’ expectations: (a) predictions of future EPS and (b) subjective confidence about their own predictions. We conduct an experiment where we hold information content constant and ask participants to evaluate multiple earnings forecasts or a single earnings estimate. Results from the experiment suggest that multiple information sources improve participants’ confidence, and participants are most confident when they receive multiple earnings forecasts with no variability. However, their confidence diminishes when variability in the multiple forecasts increases. Evidence from this study indicates that multiple information sources outperform the single source only when multiple reports have highly consistent information.

The Less You Know, the More You Are Afraid of—A Survey on Risk Perceptions of Investment Products
Mei Wang - WHU-Otto Beisheim School of Management
Carmen Keller - ETH Zurich, Institute for Environmental Decisions (IED)
Michael Siegrist - ETH Zurich, Institute for Environmental Decisions (IED)

We conducted a survey on risk perceptions of investment products in the German-speaking area of Switzerland. Unlike the typical two-factor structure documented in the previous literature, we found that knowledge-related scales were highly correlated with risk-related scales, whereas the correlation between perceived risk and historical risk measures was much lower. The respondents perceived those easier-to-understand products as less risky, which was likely driven by the familiarity bias. Our results are in line with the affect heuristic and risk-as-feelings hypotheses.

Price Patterns in Experimental Asset Markets with Long Horizon
Yaron Lahav - Ben-Gurion University of the Negev

We investigate the generality of the bubble and crash price pattern observed in previous asset market experiments. The deviation of prices from fundamental values can be explained by either a failure of subjects to backward induct, a learning effect, or some other explanation. We conduct experiments with a longer horizon of 200 periods to find a possible reason for the timing of the crash. If the reason for the crash is the inability of subjects to backward induct, a long bubble should be observed. If, on the other hand, it is a learning effect, then the crash should occur after approximately 13 periods. Our results show that while prices generally deviate from fundamental values, price patterns are different than in the 15-period markets, featuring multiple bubbles and crashes.

Prospect Theory and Risk-Seeking Behavior by Troubled Firms
Doron Kliger - University of Haifa
Iris Tsur - University of Haifa and The Technion

We employ Prospect Theory (PT, Kahneman and Tversky [1979]) to explain the relationship between risk and return at the organization level. Our modeling approach addresses shortcomings in previous research approaches. We suggest an alternative approach for inferring the reference point, a key element of PT, and measuring risk, as well as a different representation of the risk-return association taking into consideration a timeline of the firm's state, its state dependent action, and consequences. Consistent with PT, results using COMPUSTAT data show that firms with returns above their reference levels take less risk than firms with returns below their reference levels.

Dollar-Cost Averaging and Prospect Theory Investors: An Explanation for a Popular Investment Strategy
Hubert Dichtl - Alpha Portfolio Advisors GmbH
Wolfgang Drobetz - Institute of Finance, University of Hamburg

Dollar-cost averaging requires investing equal amounts of an investment sum step-by-step in regular time intervals. Previous studies that assume expected utility investors were unable to explain the popularity of dollar-cost averaging. Statman [1995] argues that dollar-cost averaging is consistent with the positive framework of behavioral finance. We assume a prospect theory investor who implements a strategic asset allocation plan and has the choice to shift the portfolio immediately (comparable to a lump sum) or on a step-by-step basis (dollar-cost averaging). Our simulation results support Statman's [1995] notion that dollar-cost averaging may not be rational but a perfectly normal behavior.

Volume 12, Number 2, 2011 Abstracts
© Copyright Taylor & Francis, LLC. 2011

Are Investors Rational and Does it Matter? Determining the Expected Utility Function for a Group of Investors
John Livanas - University of New South Wales

This paper reports on an experiment with a group of 236 Australian superannuation investors to derive an expected utility function for risk and return, and the resulting indifference curves. The paper concludes that the expected utility function is consistent with that anticipated in Markowitz [1952] and Sharpe [1964] except that the investors did not consider time horizon. The paper argues that the analysis of investor behavior is best served by considering the behavior of a group as a whole rather than investors as individuals, and by assessing their choices when faced with successive similar tasks.

Fair Value (U.S. GAAP) and Entity-Specific (IFRS) Measurements for Performance Obligations: The Potential Mitigating Effect of Benchmarks on Earnings Management
Cheri R. Mazza - John F. Welch School of Business, Sacred Heart University
James E. Hunton - Bentley University
Ruth Ann McEwen - Florida International University

A total of 86 financial managers participated in an experiment designed to assess the reliability of Level 3 fair value (U.S. GAAP) and entity-specific (IFRS) measurements of performance obligations. The study focuses on asset retirement obligations because, to date, under U.S. GAAP they are the sole performance obligation measured at fair value. The findings indicate that with a benchmark, managers tend to manage earnings less with fair value measurements than entity-specific measurements. In contrast, without a benchmark, managers tend to manage earnings irrespective of whether the obligation is measured using fair value or entity-specific value. Findings suggest that to the extent IFRS entity-specific measurements are associated with internally derived benchmarks, they may be more reliable than Level 3 fair value U.S. GAAP measurements that will not have benchmarks.

Individuals’ Affect-Based Motivations to Invest in Stocks: Beyond Expected Financial Returns and Risks
Jaakko Aspara - Aalto University School of Economics
Henrikki Tikkanen - Aalto University School of Economics

The purpose of this article is to study whether an individual investor's affect towards a company causes him extra motivation to invest in the company's stock, over and beyond expected financial returns and risk. The authors examine survey data from 400 investors. They find that most investors had affect-based, extra motivation to invest in stocks, over and beyond financial return expectations. The more positive an individual's attitude towards the company was, the stronger was his extra investment motivation. Moreover, a special affective relationship that an investor may have towards a company—affective self-affinity—can further explain the extra investment motivation.

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.

Barron's Red Flags: Do They Actually Work?
Tim Loughran - University of Notre Dame
Bill McDonald - University of Notre Dame

Investors are often concerned that managers might hide negative information in filings. With advances in textual analysis and widespread document availability, individuals can now easily search for phrases that might be red flags indicating questionable behavior. We examine the impact of 13 suspicious phrases identified by a Barron's article in a large sample of 10-Ks. There is evidence that phrases like unbilled receivables signal a firm may subsequently be accused of fraud. At the 10-K filing date, phrases like substantial doubt are linked with significantly lower filing date excess stock returns, higher volatility, and greater analyst earnings forecast dispersion.

The Role of Expectations in Value and Glamour Stock Returns
Nicholas Magnuson - Brandes Investment Partners-Brandes Institute

What happens when value and glamour stocks miss earnings expectation targets? Although, as expected, prices for glamour stocks have historically fallen, prices for value stocks have gone up—even when business fundamentals deteriorated based on results found in this study of global equities. These results suggest the superior returns delivered by value stocks may not be a result of positive developments relative to expectations but instead are more likely due to a gradual and corrective reversal of earlier overreaction and mispricing. This augments research by select scholars and provides fresh evidence explaining why value investing historically has been a successful long-term strategy.

Volume 12, Number 3, 2011 Abstracts
© Copyright Taylor & Francis, LLC. 2011

Know Your Subject: A Gendered Perspective on Investor Information Search
Cäzilia Loibl - The Ohio State University
Tahira K. Hira - Iowa State University

What causes men and women to behave differently in financial matters? Gender differences in financial decisions and behaviors have been well-documented in popular media and the managerial press. The academic literature supports the notion of gender differences in investing, pointing out that male investors tend to make the high-consequence financial decisions in households and are the more risk tolerant and self-confident investors. Yet few studies have empirically connected these conditions to differences in the information acquisition behavior of male and female investors. This paper examines whether differences exist in the information sources and the frequency of their use among male and female investors and identifies demographic and attitudinal characteristics that could cause differences in information search strategies.

Stock Market Mispricing, Executive Compensation and Corporate Investment: Evidence from Australia
Hui Li - La Trobe University
Darren Henry - La Trobe University
Hsin-I Chou - La Trobe University

This paper empirically investigates the relation between stock mispricing, the compensation of executives and directors, and corporate investment using Australian data. We find no significant relation between investment level and stock mispricing as measured by the nonfundamental component in the firm's Q ratio. We also document a significant positive relation between the magnitude of equity-based compensation, measured as the percentage of the market value of a firm's equity, and the investment level. The results suggest that managers make investment decisions that do not cater to stock market mispricing but rather that concern their equity-based compensation.

Does Prospect Theory Explain the Disposition Effect?
Thorsten Hens - University of Zurich and NNH, Norwegian School of Economics
Martin Vlcek - Banque Cantonale Vaudois

The disposition effect is the observation that investors tend to realize gains more than losses. This behavior is puzzling because it cannot be explained by traditional finance theories. A standard explanation of the disposition effect refers to prospect theory and, in particular, to the asymmetric risk aversion, according to which investors are risk-averse when faced with gains and risk-seeking when faced with losses. We show that for reasonable parameter values, the disposition effect cannot, however, be explained by prospect theory. The reason is that those investors who sell winning stocks and hold losing assets would not have invested in stocks in the first place. That is, the standard prospect theory argument is sound ex-post, assuming that the investment occurred, but not ex-ante, requiring also that the investment has to be made in the first place.

Investor Optimism, False Hopes and the January Effect
Stephen J. Ciccone - University of New Hampshire Whittemore School of Business and Economics

This paper proposes that the January Effect is at least partly explained by a behavioral framework based on optimistic expectations. The turn-of-the-year is hypothesized to be a time of renewed optimism. Indeed, investor sentiment, as measured by the University of Michigan's Index of Consumer Confidence, peaks in January. Thus, optimists are expected to bid up the stock prices of firms with higher levels of uncertainty in January. These firms will subsequently underperform as they disappoint investors during the remainder of the year. Despite the disappointment, the January pattern persists due to the “false hope syndrome” described in the psychology literature. Using forecast dispersion to proxy for uncertainty, the results are consistent with the optimism hypothesis. Similar reasoning may help explain other anomalies.

Explaining What Leads Up to Stock Market Crashes: A Phase Transition Model and Scalability Dynamics
Rossitsa Yalamova - University of Lethbridge
Bill McKelvey - UCLA Anderson School of Management

Mathematical descriptions of financial markets with respect to the efficient market hypothesis (EMH) and fractal finance are now equally robust but EMH still dominates. EMH and other current paradigms are extended to accommodate situations having higher information complexity and interactions coupled with positive feedback. The “herding behavior” literature in finance marks a significant recognition that interdependent trader behavior may result in deviation from normal distribution of returns, as does “chartist” trading. Further legitimization of the separate-but-equal status of EMH and fractal finance is pursued. Research on the nonlinear models giving theoretical underpinning to equations representing mirror markets as complex dynamical systems is encouraged. Why some herding- and chartist-behaviors scale up and then die off whereas others result in significant crashes is explained. The buildup to the 2007 liquidity crisis offers an example of nonlinear scale-free dynamics. Concepts from complexity science, econophysics, and scale-free theory are used to offer further explanation to physicists’ mathematical treatments.

Reverse Disposition Effect of Foreign Investors
Tõnn Talpsepp - TSEBA, Tallinn University of Technology

The paper analyses the tendency of investors to realize gains too early and the reluctance to liquidate losing positions. Analysis is based on the complete transaction data of the Estonian stock market. The Cox proportional hazard model along with ratio analysis is used to measure the disposition effect. I find presence of the disposition effect on the market, but contrary to other investor groups, foreign investors seem to exhibit a “reverse disposition effect” that can be caused by different behavioral characteristics compared to local investors, especially risk aversion. Foreign investors are more driven by momentum strategies whereas local investors pursue the contrarian approach. Experience and investor sophistication seem to decrease the disposition effect.

Retirement Investor Risk Tolerance in Tranquil and Crisis Periods: Experimental Survey Evidence
Hazel Bateman - University of New South Wales
Towhidul Islam - University of Guelph
Jordan Louviere - University of Technology Sydney
Stephen Satchell - University of Cambridge
Susan Thorp - University of Technology Sydney

We conduct a choice experiment to investigate the impact of the financial crisis of 2008 on retirement saver investment choice and risk aversion. Analysis of estimated individual risk parameters shows a small increase in mean risk aversion between the relatively tranquil period of early 2007 and the crisis conditions of late 2008. Investment preferences of survey respondents, estimated using the scale-adjusted version of a latent class choice model, also change during the crisis. We identify age and income as important determinants of preference classes in both surveys and age is also identified as a key determinant of variability (scale). Young and low income individuals make choices that are more consistent with standard mean-variance analysis, but older and higher income individuals react positively to both higher returns and increasing risk in returns. Overall we find a mild moderating of retirement investor risk tolerance in 2008.

Testing Alternative Theories of Financial Decision Making: A Survey Study With Lottery Bonds
Patrick Roger - EM Strasbourg Business School, Strasbourg University

We present the results of a simple, easily replicable, survey study based on lottery bonds. It is aimed at testing whether agents make investment decisions according to expected utility, cumulative prospect theory or optimal expectations theory, when they face skewed distributions of returns. We show that more than 55% of the 245 participants obey optimal expectations theory. They choose a distribution of payoffs dominated for second-order stochastic dominance and which would not be chosen according to cumulative prospect theory, for a large range of parameter values. As by-products of this study, we illustrate that agents use heuristics when they choose numbers at random and have, in general, a poor opinion about the rationality of others.

The Impact of Venture Capital Investments on Public Firm Stock Performance
Tim Loughran - University of Notre Dame
Sophie Shive - University of Notre Dame

The aggregate amount of venture capital investments in nonpublicly traded firms since 1980 is more than $390 billion. We test two economic hypotheses on the connection between venture capital investment and subsequent firm performance. We find that lagged VC investments scaled by industry assets are negatively related to subsequent firm stock returns after adjusting for other factors. However, not all firms are equally impacted. We find that financially constrained firms suffer the most when new VC money pours into an industry. Firms receiving VC money are active in patent creation which appears to increase innovation pressures on established companies. It appears that the market is slow to incorporate the information contained in the venture capital investments.