Volume 16, Number 1, 2015 Abstracts
© Copyright Taylor & Francis, LLC. 2015

The Use of Word Lists in Textual Analysis
Tim Loughran - University of Notre Dame
Bill McDonald - University of Notre Dame

A commonly used platform to assess the tone of business documents in the extant accounting and finance literature is Diction. We argue that Diction is inappropriate for gauging the tone of financial disclosures. About 83% of the Diction optimistic words and 70% of the Diction pessimistic words appearing in a large 10-K sample are likely misclassified. Frequently occurring Diction optimistic words like respect, security, power, and authority will not be considered positive by readers of business documents. Similarly, over 45% of the Diction pessimistic 10-K word-counts are not and no. The Loughran-McDonald [2011] dictionary appears better at capturing tone in business text than Diction.

Impact of Information Disclosure on Prices, Volume, and Market Volatility: An Experimental Approach
Yang Zhang - Beijing Forestry University
Hong Zhang - Tsinghua University
Michael J. Seiler - Old Dominion University

This study integrates experimental design with econometric techniques to examine the impact of information disclosure on trading prices, trading volume, and market volatility. Using a double auction model, we find that as information disclosure increases, trading prices and trading volume remain the same. However, the volatility in the marketplace is significantly reduced. This overall market efficiency gain is robust to a number of different efficiency metrics.

Why Might Investors Choose Active Management?
F. Douglas Foster - University of Technology, Sydney
Geoffrey J. Warren - Australian National University

We investigate why investors may be willing to participate in active management, notwithstanding expectations for negative average alpha after fees across all managers. Our approach involves modeling the expected outcome from investing in a portfolio of active managers, for investors who believe they have ability to select good managers and may anticipate benefits from replacing managers when alpha expectations fall. Numerical calibrations using inputs consistent with the literature find that certain investors can credibly invest through active managers at observed fee levels, most notably institutions. However, participation in active management at fees paid by some retail investors can only be explained by allowing for behavioral biases. Our analysis suggests that the wide use of active management reflects a diversity of investors who form expectations based on information other than expected alpha for the average manager, some of which entails cognitive error.

Adaptive Trading and Longevity
Ryan Garvey - Duquesne University
Fei Wu - Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University

We examine the relationship between trader longevity and trader behavior changes in U.S. equity markets. Traders who change how much, what, when, and where they trade often remain active for a longer period of time. Although longer (shorter) duration traders tend to perform better (worse), changes in trader behavior rather than in performance are the key determinants of longevity. Overall, our findings suggest that securities traders who are able to adapt and alter how they trade in light of continually changing market conditions are more successful.

Investor Sentiment and Stock Market Liquidity
Shuming Liu - San Francisco State University

Recent research on liquidity has reported that aggregate liquidity in the stock market varies over time, and evidence suggests that this variation affects stock returns. Although the importance of market liquidity in asset pricing has been well documented, little is known about what causes stock market liquidity to vary over time. This paper examines whether the time-series variation in stock market liquidity is related to investor sentiment. Using the liquidity measure developed by Amihud [2002] and two survey-based investor sentiment indices, I find that the stock market is more liquid when sentiment indices rise, that is, when investors are more bullish. Moreover, the Granger causality tests suggest that investor sentiment Granger-causes market liquidity. Further analyses show that market trading volume also increases when investor sentiment is higher. In addition, the finding that the market is more liquid when investor sentiment is higher still persists even after controlling for the effect of market trading volume. These results are consistent with the theoretical prediction that investor sentiment increases stock market liquidity.

On the Persistence of Overconfidence: Evidence From Multi-Unit Auctions
Emmanuel Morales-Camargo - The University of Texas Arlington
Orly Sade - Hebrew University of Jerusalem
Charles Schnitzlein - The University of Vermont
Jaime F. Zender - University of Colorado at Boulder

We analyze pre- and post-task confidence in an experiment in which subjects bid in multiunit common value auctions. Subjects return for a second session, so we are able to assess how performance affects the evolution of confidence. Those with low confidence prior to the first session underestimate performance while those with high confidence overestimate performance. Although the average change in pre-experiment confidence from session one to session two is close to zero, the dispersion in confidence increases. For those with moderate initial confidence, the change in confidence depends significantly on performance in session one. For those with high initial confidence, the change in confidence does not depend on performance, and the correlation between confidence prior to session two and confidence prior to session one is significantly higher than for those with neutral or low confidence. Subjects with high initial confidence also base their perception of post-experiment relative performance primarily on pre-experiment confidence, an effect not present in the moderate and low confidence groups. Based on a pre-experiment survey, we also find that those with high initial confidence are more likely to have prior experience trading stocks or options.

Investor Sentiment and Short-Term Returns for Size-Adjusted Value and Growth Portfolios
Doug Waggle - University of West Florida
Pankaj Agrrawal - University of Maine

We examine the sentiment levels of individual investors relative to subsequent short-term market returns for 1992–2010. We find that sentiment, proxied by percentage of investors who are “bullish” on the market, is significantly negatively related to the subsequent three- and six-month performance of the market. The negative relationship is consistent with the contrarian notion of sentiment. In other words, high (low) levels of bullishness tend to be followed by subsequent low (high) returns. This is true even with the inclusion of standard control explanatory variables (Fama-French [1993]). While the significant results hold for the overall market, they are clearly driven by growth, rather than value stocks. Contrary to some earlier studies, we also note significant explanatory power for sentiment when looking at returns of small-, mid-, and large-cap growth stocks. We also noted that the long-term moving average of monthly bullishness increased from 33.3% to 39.0% over the last 18 years. In our study period, about 5% of the total sentiment observations are above 56% (very bullish) and about 5% are below 27% (quite bearish). Finally, we find some strength in the lagged autocorrelation structure for the sentiment variable that lasts for just about three to nine months.

How Investor Perceptions Drive Actual Trading and Risk-Taking Behavior
Arvid O. I. Hoffmann - Maastricht University
Thomas Post - Maastricht University
Joost M. E. Pennings - Maastricht University

Recent work in behavioral finance showed how investors' perceptions (i.e., return expectations, risk tolerance, and risk perception) affect hypothetical trading and risk-taking behavior. However, are such perceptions also capable of explaining actual trading and risk-taking behavior? To answer this question, we combine monthly survey data with matching brokerage records to construct a panel dataset allowing us to simultaneously examine investor perceptions and behavior. We find that investor perceptions and changes therein are important drivers of actual trading and risk-taking behavior: Investors with higher levels of and upward revisions of return expectations are more likely to trade, have higher turnover, trade larger amounts per transaction, and use derivatives. Investors with higher levels of and upward revisions in risk tolerance are more likely to trade, have higher buy-sell ratios, use limit orders more frequently, and hold riskier portfolios. Investors with higher levels of risk perception are more likely to trade, have higher turnover, have lower buy-sell ratios, and hold riskier portfolios.


Volume 16, Number 2, 2015 Abstracts
© Copyright Taylor & Francis, LLC. 2015

Time-Varying Market Price of Risk and Investor Sentiment: Evidence from a Multivariate GARCH Model
David W. Johnk - University of Texas – Pan American
Gökçe Soydemir - California State University – Stanislaus

We test a conditional version of the CAPM in the U.S. equity market using a parsimonious generalized autoregressive conditional heteroskedasticity (GARCH) model in which the risk premia, betas, and correlations vary through time. We introduce U.S. investor sentiment from two surveys as conditional information variables, whereas previous studies generally use economic fundamentals. We assume that investor sentiment is not entirely irrational and decompose it into its irrational and rational components; using the irrational components as information variables. We find that irrational investor sentiment measures are statistically significant, and contain information which may be valuable in asset pricing models.

An Experimental Study of the Effect of Market Performance on Annuitization and Equity Allocations
Julie R. Agnew - College of William and Mary
Lisa R. Anderson - College of William and Mary
Lisa R. Szykman - College of William and Mary

Although researchers have studied the annuity puzzle for years, it has only recently been analyzed from a behavioral finance standpoint. This paper adds to this new stream of literature by using experimental methods to investigate how market performance affects the decision to annuitize. Using a large-scale, controlled laboratory experiment, this paper finds evidence that excessive extrapolation may be influencing this decision. In addition, we find that past market performance influences subsequent portfolio allocation decisions. This paper serves as a useful complement to recent studies using administrative data. Our experimental approach allows us to more cleanly test the role of past market performance by carefully controlling for many factors that may confound the analysis of administrative data.

Stock Market Image: The Good, the Bad, and the Ugly
Dawn M. Dobni - University of Saskatchewan
Marie D. Racine - University of Saskatchewan

This paper introduces the concept of stock market image and presents a six-dimension scale for measuring it. Using cross-sectional survey data, application of the scale reveals that retail investors have widely heterogeneous perceptions of the stock market ranging from highly positive to highly negative. Five image profiles were generated using cluster analysis, each representing a different perspective on the stock market. These profiles were found to reflect personal and subjective characteristics of investors, including financial knowledge and investing experience. Understanding stock market image is important because it influences investing behaviors, expectations, and experiences, including the decision to participate in or avoid equities markets. Members of the stock market supply chain are thus encouraged to consider their roles and responsibilities in managing, promoting, and improving it.

Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions
Eben Otuteye - University of New Brunswick Fredericton
Mohammad Siddiquee - University of New Brunswick Saint John

Investment decisions are subject to error due to cognitive biases of the decision makers. One method for preventing cognitive biases from influencing decisions is to specify the algorithm for the decision in advance and to apply it dispassionately. Heuristics are useful practical tools for simplifying decision making in a complex environment due to uncertainty, limited information and bounded rationality. We develop a simple heuristic for making value investing decisions based on profitability, financial stability, susceptibility to bankruptcy, and margin of safety. This achieves two goals. First, it simplifies the decision making process without compromising quality, and second, it enables the decision maker to avoid potential cognitive bias problems.

The Freeze-out Bond Exchange Offer: An Experimental Approach
Flavio Bazzana - University of Trento
Luigi Mittone - University of Trento
Luciano Andreozzi - University of Trento

If a firm wants to withdraw a covenant on a issued bond, it can attempt a consent solicitation combined with an exchange offer (the freeze-out exchange offer). If the bondholders are not fully coordinated, the shareholders can make the exchange offer unfair by issuing the new bond at a price that is lower than the market price. We perform two experiments to isolate (i) the level of information and (ii) the role of the experience of the bondholders in a freeze-out bond exchange offer. In the first experiment, the experience of the participants is a dominant factor compared to access to information. The choice of the symmetric Nash equilibrium, in which every participant accepts the exchange offer, increases with experience. Conversely, in the second experiment, which offers a lower level of experience, the information provided is the dominant factor. In this experiment relative to the first one, the choice of the symmetric Nash equilibria decreases, and the choice of the Pareto superior asymmetric Nash equilibrium, in which two participants reject the exchange offer and the other accepts it, increases. These results have policy implications that may affect exchange offers in the bond market.

Are Emerging Market Investors Overly Pessimistic in Extreme Risk-off Periods?
Jan Viebig - University of Bremen

Motivated by Campbell and Shiller [2001], we ask if future returns and loss probabilities are predictable when markets trade at extremely low, depressed levels. In this paper we present empirical evidence that a predictable “undershooting phenomenon” exists in emerging markets. Depressed valuation ratios are a statistically significant predictor at the 99% level of confidence for future returns in most emerging markets. Overly anxious emerging market investors seem to overreact in periods of extreme stress and fear in financial markets.

Detecting Lies in the Financial Industry: A Survey of Investment Professionals' Beliefs
Maria Hartwig - The City University of New York
Jason A. Voss - CFA Institute – Product Solutions
D. Brian Wallace - New School for Social Research

Research suggests that interpersonal deception is a common phenomenon in many settings. However, to date no research has examined lying and lie detection in the financial industry. This paper presents an empirical examination of investment professionals' beliefs about deception. We obtained survey data from 607 CFA Institute charter holders across the world. Three aspects of deception were included in the survey. First, respondents' beliefs about the behavioral characteristics of lying were examined. Second, perceptions of the prevalence of lies in professional and everyday life were mapped. Third, respondents were asked to estimate their ability to distinguish between lies and truths. The results showed that respondents subscribed to common misconceptions about deceptive behavior, in particular the beliefs that liars are gaze aversive and fidgety. Respondents believed that lying occurs on a daily basis, and that their accuracy in detecting lies exceeds 65%. Previous research suggests that this estimate may be overconfident. Implications of these results and directions for future research on deception in the financial industry are discussed.

Asset Legitimacy in Experimental Asset Markets
Debapriya Jojo Paul - UNSW Australia
Julia Henker - Bond University
Sian Owen - UNSW Australia

We investigate whether prices in experimental asset markets behave differently when participants are required to trade with earned wealth compared to unearned wealth. Unearned endowed wealth, the standard practice in experimental studies of asset price bubbles, may elicit greater than normal risk-seeking behavior. We test for this altered behavior by requiring some participants to earn their initial market allocation. We do not find a significant difference in the frequency, severity, or duration of mispricing between earned and unearned endowments. Our results confirm the validity of the existing methodologies used in the study of bubbles in experimental settings.


Volume 16, Number 3, 2015 Abstracts
© Copyright Taylor & Francis, LLC. 2015

Born for Finance? Experimental Evidence of the Impact of Finance Education
Bryan C. McCannon - Saint Bonaventure University
Jeffrey Peterson - Saint Bonaventure University

What impact does a finance education have on the behaviors of individuals? Experiments of an investment game are conducted where a wealth-creating investment decision is made. After it grows, the recipient selects how much to return. The econometric method used allows for a disentangling of the selection effects from learning. We show that finance students are both born and made. Those who choose to study finance do not necessarily make trusting investments or volunteer to return the proceeds, but the effect of the education is to reverse these behaviors promoting pro-social, trusting, and reciprocating choices that generate wealth.

Investor Sentiment and Financial Market Volatility
Hui-Chu Shu - Shih Chien University
Jung-Hsien Chang - National Chi Nan University

Empirical studies have documented the influence of investor sentiment on financial markets, but the underlying economic mechanism remains unclear. This study links psychological research and a traditional asset-pricing model to investigate the influence of investor sentiment variations on financial markets. By relaxing the assumption of investor rationality, this investigation shows that a modified Lucas [1978] model can adequately interpret prominent financial market anomalies, such as high volatility, bubble and crash formation, and the relationships among investor sentiment, asset prices and expected returns.

Brain Activity of the Investor's Stock Market Financial Decision
João Paulo Vieito - Polytechnic Institute of Viana do Castelo
Armando Freitas da Rocha - RANI – Research on Artificial and Natural Intelligence
Fabio Theoto Rocha - IPTI and RANI – Research on Artificial and Natural Intelligence

Using electroencephalogram technologies (EEG) to map the brain, this investigation is among the first to analyze if the same brain circuits are used when making buying, selling, or holding stock decisions and if different circuits are used when market conditions change such as in a growing market or a high volatility market. Two groups of 20 volunteers were used. One group initiated the trading process in a market with steadily increasing prices and then moved to a high volatility market, and the second group started trading in a high volatility market and then in a growing market.

Results are quite innovative in the area of finance: brain mapping associated with such decisions differs between these two groups, and also when buying, selling, or holding decisions were made. These results clearly demonstrate that people may use different reasoning strategies to make financial decisions depending on their trading experience.

Subjective Probability in Behavioral Economics and Finance: A Radical Reformulation
H. Joel Jeffrey - Northern Illinois University
Anthony O. Putman - Descriptive Psychology Institute

Behavioral finance depends intimately on the notion of subjective probability, which has been universally treated as one of the two forms of probability. A substantial body of work and recent experimental results show conclusively that this approach is invalid: subjective and objective probabilities cannot be treated as two sides of the same coin. This raises serious questions about calculations based on that assumption, decisions based on those calculations, and what to do if assigning numerical values and calculating expected values based on subjective probabilities is invalid. This paper presents a radical re-formulation of subjective probability, showing that what have been called “subjective probabilities” are properly formulated as uncertainty appraisals, re-descriptions of states of affairs carrying tautological implications for action. A novel formulation of the decision maker's field-of-view, based on the concept of Actor, Observer, and Critic roles, combined with the uncertainty appraisal formulation, is used to develop new methods for evaluating data, finding patterns in data, and integrating probabilities and uncertainty appraisals, that is, those aspects that have, until now, been called “subjective probabilities.”

Wealth Maximization in the Context of Blind Trust – A Neurobiological Research
Olivier Mesly - University of Québec in Outaouais (UQO) and Université Sainte-Anne

This paper reviews the paradigm of financial decision making as being oblivious to sentiments such as blind trust. It is based on a recent neurobiological study in which participants' brains were scanned using functional magnetic resonance imaging (fMRI) technology. The study was devised on the tenets of the consolidated model of financial predation (CMFP). It is shown that participants do not target profit maximization concurrently with cost minimization when put in a situation of blind trust. Trust is revealed as a multidimensional construct having mathematical links with other constructs such as perceived predation, cooperation and reward.

Investor Inattention and Under-Reaction to Repurchase Announcements
Lee-Young Cheng - Minhsiung, Chaiyi, Taiwan, R.O.C.
Zhipeng Yan - New Jersey Institute of Technology
Yan Zhao - City College of New York, CUNY
Li-Ming Gao - National Chung Cheng University

This paper investigates investor inattention as a plausible explanation for market reaction to repurchase announcements. We use prior turnover as the proxy for investor attention to examine the difference in stock price performance between low-attention stocks and high-attention stocks. We find that low prior turnover firms experience greater underreaction to repurchase announcements than high prior turnover firms. Low prior turnover firms also experience larger positive long-run excess returns following announcements. Furthermore, a higher level of investor's inattention leads to higher degree of underreactions, resulting in higher actual completion rates.


Volume 16, Number 4, 2015 Abstracts
© Copyright Taylor & Francis, LLC. 2015

Risk Information and Retirement Investment Choice Mistakes Under Prospect Theory
Hazel Bateman - UNSW Australia
Ralph Stevens - UNSW Australia
Andy Lai - Taylor Fry Analytics and Actuarial Consulting

We assess alternative presentations of investment risk using a discrete choice experiment which asked subjects to rank three investment portfolios for retirement savings across nine risk presentation formats and four underlying risk levels. Using Prospect Theory utility specifications, we estimate individual-specific parameters for risk preferences in gains and losses, loss aversion, and error propensity variability. Our results support presentations that describe investment risk using probability tails. Risk preferences and error propensity were found to vary significantly across sociodemographic groups and levels of financial literacy. Our findings should assist regulatory efforts to disclose risk information to the mass market.

A Cumulative Prospect View on Portfolios that Hold Structured Products
Jürgen Vandenbroucke - University of Antwerp and KBC Asset Management

Many investors hold structured products in their portfolio. The current paper develops a break-even analysis on how this presence of structured products can be understood based on cumulative prospect theory. The framework provides additional insights into the behavioral conditions and required return expectations that make investors buy into expensive structured products with uncertain rewards. We make the strong assumption that the structured product has a zero prospect value when considered as a stand-alone investment. Still the optimized portfolio typically includes structured products. The degree of probability distortion determines the entry of structured products in the optimal portfolio. Once included it is the curvature of the value function that guides the actual weight of structured products and the potential increase in portfolio prospect value. Structured products receive a higher weight and increase the portfolio prospect value more if the investor is less conservative.

Trading Behavior of Institutional Investors and Stock Index Futures Returns in Taiwan
Hung-Cheng Lai - Overseas Chinese University
Kuan-Min Wang - Overseas Chinese University

In this study, the relationship between three institutional investors' trading behaviors and Taiwan stock index futures returns is investigated. Empirical results show that foreign institutional investors (FINI) in the futures market are negative feedback traders while the investment trusts are positive feedback traders. Both trading behaviors follow the returns of index futures. Moreover, the net trading volume of FINI has a significantly positive effect on Taiwan stock index futures returns. In addition, the impact of Taiwan stock index returns for the open interest has a persistent effect. Finally, it was found that extreme net open interest of dealers predicts Taiwan stock index futures.

Trading Volume, Heterogeneous Expectations, and Earnings Announcements
Huong Dinh - University of Paris East – Accenture
Jean-François Gajewski - IREGE – University Savoie Mont Blanc

Using the experimental method, this paper provides evidence that the dispersion of beliefs is the main driver behind trading volume. However, in contrast with existing literature, we show that the relationship between trading volume and heterogeneity of expectations is more concave than linear. We study investors' reactions in terms of trading volume to the announcement of earnings. The experiment shows that heterogeneity of expectations does not decrease when investors have more information about the final results. This heterogeneity is also the main factor behind transactions in our experimental asset markets. However, too large a dispersion in expectations dissuades investors from trading.

Misvaluation and Behavioral Bias in Financial Markets
Jayendra Gokhale - Embry Riddle Aeronautical University
Carol Horton Tremblay - Oregon State University
Victor J. Tremblay - Oregon State University

Early models in finance posit that security prices respond quickly to new information and accurately reflect their fundamental values. More recent work indicates that market frictions and the psychological limitations of traders can cause asset prices to deviate from their fundamental values for a considerable length of time. In this paper, we develop an empirical method that tests for and estimates the degree of valuation bias. Being better able to detect valuation bias reveals profit opportunities and may improve the efficiency of financial markets if it sufficiently changes trader behavior.

Information Diffusion and Momentum in Laboratory Markets
Shengle Lin - San Francisco State University

Theories emphasize the market's capacity of correctly aggregating disperse information so long as the market holds complete information. Recent empirical evidences suggest that the extent of information aggregation also depends upon the dissemination of existing information. In laboratory market, I investigate the market's aggregation capacity in response to the spreading of existing information. The results demonstrate that prices gradually converge to intrinsic value and exhibit momentum in the process of information diffusion. The analysis suggests that aggregation of disperse information is mitigated by the presence of equilibrium multiplicity.

Analyst Herding Behavior and Analyst Affiliation: Evidence from Business Groups
Junghee Lee - IÉSEG School of Management
Jung-wha Lee - The Australian National University

This paper examines analysts herding behavior when there are two groups of analysts where one group has affiliation with the subject firm and one group does not. We found that the unaffiliated analysts issue the forecasts herding towards their prior affiliated analysts' forecasts. The unaffiliated analysts' herding with affiliated analysts is intensified by positive information delivered by affiliated analysts. In addition, the herding with affiliated analysts results from unaffiliated analysts' strategic actions to maximize forecast accuracy. Overall, when significant information asymmetry exists, the findings suggest that unaffiliated analysts use affiliated analysts' forecasts as a primary information source to forecast earnings.

EOV Editorial Board