Volume 3

Volume 3, Number 1, 2002 Abstracts
© Copyright Erlbaum 2002

Introduction to the Institute's June 2001 Conference:
A Multidisciplinary Approach to Understanding Bubbles

In June 2001, The Institute of Psychology and Markets presented a conference entitled "The Disintegration of History's Largest Bubble." This conference featured a number of scholars from diverse disciplines within economics, finance, psychology and public policy. The presentations sought to shed light on the behavior and decision making that led to the internet/ high-tech bubble of the late 1990's and the subsequent collapse. A related conference that was open to the general public was held in October 2001.

Transcripts

Bubbles and the Role of Analysts' Forecasts
David Dreman

Asset Markets
Gunduz Caginalp, David Porter and Vernon Smith

Market Efficiency of Bubbles
Colin Camerer

The Changing Nature of the Initial Public Offering Market
Timothy Loughran

Imagery and Financial Judgment
Donald G. MacGregor

Blowing Bubbles
Kenneth L. Fisher
Meir Statman

The forecasts of individual investors, surveyed by Gallup/PaineWebber, imply that they believed that the market was in a bubble in the late 1990s and expected the bubble to continue to inflate; many investors thought that the stock market was overvalued in the late 1990s but many also thought that it was a good time to invest. The forecasts of institutional investors, surveyed by Business Week, imply that they too believed that the market was in a bubble in the late 1990s, but they expected the bubble to burst. Institutional investors were bearish in the late 1990s, but turned bullish after the stock market decline of 2000, while individual investors turned bearish

Can Markets Learn to Avoid Bubbles?
Ross M. Miller

One of the most striking results in experimental economics is the ease with which market bubbles form in a laboratory setting and the difficulty of preventing them. This article reexamines bubble experiments in light of the results of an earlier series of market experiments that show how learning occurs in markets characterized by an asymmetry of information between buyers and sellers, such as found in Akerlof's lemons model and Spence's signaling model. Markets with asymmetric information are incomplete because they lack markets for specific levels of product quality. Such markets either lump all qualities together (lemons) or using external indications of quality to separate them (signaling). Similarly, the markets used in bubble experiments are incomplete in that they are lacking a complete set of forward or futures markets, depriving traders of the information supplied by the prices in those markets. Preliminary experimental results suggest that the addition of a single forward market can sometimes mitigate bubble formation and this article suggests more extensive research in this direction is warranted. Market bubbles outside of the laboratory usually are found in markets in which forward and futures markets are either legally restricted or otherwise limited.

Experimentation in markets with asymmetric information also indicates that the ability of subjects to learn how to send and receive signals can be enhanced by changing the way that market information is presented to them. We explore how this result might be used to help asset markets learn to avoid bubbles.

Volume 3, Number 2, 2003 Abstracts
© Copyright Erlbaum 2002

Does the Market Have a Mind of Its Own, and Does It Get Carried Away With Excess Cash?
Gunduz Caginalp-University of Pittsburgh

Bubble, Rubble, Finance in Trouble?
Andrew W. Lo-Massachusetts Institute of Technology

The Irrationality of Markets
Robert Shiller-Yale University

Individual Decision Making and Group Decision Processes
John Payne-Duke University
Arnold Wood-Martingale Asset Management

Risk Perception, Risk Communication, Risk Taking
Baruch Fischhoff-Carnegie Mellon University

Thought Contagions in Deflating and Inflating Phases of the Bubble
Aaron Lynch

Do Speculative Stocks Lower Prices and Increase Volatility of Value Stocks?
Gunduz Caginalp-University of Pittsburgh
Vladimira Ilieva-University of Arizona
David Porter-George Mason University
Vernon Smith-George Mason University

The influence of speculative stocks on value stocks is examined through a set of economics experiments. The speculative asset is designed to model a company involved in a rapidly growing market that will be saturated at some unknown point. Using a control experiment where both assets are similar value stocks, we find statistical support for the assertion that the presence of a speculative stock increases the volatility and diminishes the price of the value stock. In addition, the temporal minimum price of the value stock during the last phase of the experiment is lower in the presence of the speculative stock (when the trading price of the speculative asset is declining sharply). These results indicate that an overreaction in the speculative stock tends to divert investment capital away from other assets. An examination of the relative magnitude of monthly closing price changes confirm strong correlations between the Dow Jones Average and the more speculative Nasdaq index during the time period 1990 to 2001 and particularly during the two years prior to the peak in March 2000 (0.72 correlation) and the March 2000 to August 2001 decline (0.79 correlation). Supplementary experiments using independent (or legally separate) markets trading the same asset show that a higher price in one market does not lead to a higher one in the other.

RESEARCH ELSEWHERE
Robert A. Olsen-Decision Research

BOOK REVIEWS
Robert A. Olsen-Decision Research

Volume 3, Number 3, 2003 Abstracts
© Copyright Erlbaum 2002

Analysts' Conflicts-Of-Interest: Some Behavioral Aspects
David Dreman-Dreman Value Management

Market Underreaction and Overreaction of Technology Stocks
Aigbe Akhigbe-University of Akron
Stephen J. Larson-Eastern Illinois University
Jeff Madura-Florida Atlantic University

Several studies have assessed stock market under- or overreaction of stocks and there is some agreement among them. However, there is much disagreement about what constitutes market underreaction or overreaction, and the conditions that cause it. The substantial variation in results among studies may be partially attributed to the types of firms that are contained in any sample. We investigate this premise by focusing on a sample of technology stocks that experienced an extreme change in stock price, along with a corresponding control sample of non-technology stocks that experienced a similar extreme change in stock price on the same day.

Based on the subsequent stock price behavior of each sample, we find a greater degree of overreaction within extreme positive changes in technology stock prices (winners) than in non-technology stock prices. In addition, we find a greater degree of underreaction within extreme negative changes in technology stock prices (losers) than in non-technology stock prices. When considering winners and losers collectively for technology and non-technology firms, it appears the market is overoptimistic when it initially revalues technology stock prices relative to non-technology stock prices.

The degree of under- or overreaction of technology stocks varies within the sample of technology stocks, and is conditioned on firm-specific characteristics. Overall, our results suggest that technology stocks exhibit unique stock price behavior subsequent to an extreme change in price, and that this unique behavior can even vary among technology firms according to firm-specific characteristics.

Expert Judgments: Financial Analysts Versus Weather Forecasters
Tadeusz Tyszka-Centre for Market Psychology of Leon Kozminski Academy
Piotr Zielonka-Centre for Market Psychology of Leon Kozminski Academy

Two groups of experts, financial analysts and weather forecasters, were asked to predict corresponding events (the value of the Warsaw Stock Exchange Index and the average temperature of the next month). When accounting for inaccurate judgments, we find that weather forecasters attach more importance to probability than financial analysts. Although both groups revealed the overconfidence effect, it was significantly higher among financial analysts. These results are discussed from the perspective of learning from experience.

Professional Investors as Naturalistic Decision Makers: Evidence and Market Implications
Robert A. Olsen-Decision Research

This paper is the first to examine investment decision-making from a naturalistic decision perspective. Naturalistic decision procedures tend to be used by experts making decisions in complex, ill-structured, and indeterminate situations. Survey results indicate that investment professionals, like other naturalistic decision-makers, rely heavily on mental imagery, reasoning by analogy, and decision procedures that become more intuitive as complexity increases. Also, they are "satisficers," not optimizers. In other words, their primary aim is to make an acceptable choice; finding the best choice is not necessary. Clinical training is recommended to improve the performance of investment professionals. In particular, investment professionals may benefit from training similar to that given to medical professionals wherein emphasis is placed to extensive repetitive exposure to "real world" decisions complete with plenty of immediate and unambiguous feedback.

On the Evaluation of Options on Lotteries: An Experimental Study
Tal Shavit-Technion - Israel Institute of Technology
Doron Sonsino-Technion - Israel Institute of Technology
Uri Benzion-University of Negev

We present the results of a comparative experimental study of the evaluation of simple lotteries and call/put/insurance options on these lotteries. The main findings and conclusions are:

(a) The observed bidding patterns depend on the type of asset under evaluation. In particular, subject behavior when buying or selling a basic lottery seems much more cautious than their behavior when buying or selling options on that lottery.

(b) The observed bidding patterns also depend on subject positions with respect to the underlying asset. In particular, the bids for buying lotteries and options long are statistically uncorrelated with the bids for selling the same lotteries and options short.

(c) Subjects with extreme risk attitudes are more inclined to violate basic no-arbitrage conditions (like the call-put parity) when bidding for the different lotteries.

We demonstrate that it is difficult to reconcile the experimental evidence with mainstream theories on individual decision and choice (although we find strong support for prospect theory in some parts of the data). We conclude that the evaluation of options on lotteries is context-dependent and subtler than perceived by existing theories.

Covered Call Investing in a Loss Aversion Framework
Karyl B. Leggio-University of Missouri at Kansas City
Donald Lien-University of Texas at San Antonio

In a mean-variance framework, the covered call investment strategy has been seen as an inefficient method of allocating wealth. Covered calls reduce the riskiness of the portfolio and therefore lead to lower portfolio returns. Recent debate has focused on the shortcomings of mean-variance efficiency as an accurate depiction of investor utility. Using alternative utility functions, we find mixed support for the use of the covered call investing strategy. Using loss aversion, however, we reexamine the covered call investment decision and find it significantly enhances investor utility relative to an index portfolio investment strategy. We conclude that loss aversion's more accurate depiction of investor preferences and behavior helps to explain the popularity of the covered call investment strategy.

Research Elsewhere
Robert A. Olsen-Decision Research

Book Reviews
Patric Andersson-Center for Economic Psychology, Stockholm School of Economics
Robert A. Olsen-Decision Research

Stock Analysts: Experts on Whose Behalf?
Brian Bruce-Panagora Asset Management

Investors rely on the opinions of experts to help us pick stocks. Whether one buys stocks through a 401(k) plan, or manage the mutual fund for individuals investing in the 401(k) the decision maker utilizes expert opinion. Those experts are supposed to be stock analysts. Recent scandals like Enron have caused these analysts to be much maligned. We will examine the role of those analysts, their motivations and the amount of useful information they provide.

The Perception of Dividends By Management
George Frankfurter-Louisiana State University, Sabanci University
Arman Kosedag-Sabanci University
Hartmut Schmidt-University of Hamburg
Mihail Topalov-University of Hamburg

The "dividend puzzle," i.e., the love stockholders have for dividends, has always been one of the great mysteries of modern finance/financial economics. Six classes of dividend theories have been advanced during the last five decades, almost all using the logic of the economic person. Unfortunately, all these models suffer from either a lack of verifiability or contradicting empirical evidence. This paper takes an approach that has been largely ignored so far by dividend research. Instead of analyzing large volumes of market data based on yet another "rational" model, we study the perception of dividends by top corporate decision-makers. The respondents' answers to a survey instrument are then analyzed and compared with accounting, economic, and market data. The results are surprising in terms of both similarity and dissimilarity of perception. We hope that our results and this type of research will open up new ways of looking at this puzzle.

"Buy on the Rumor:" Anticipatory Affect and Investor Behavior
Richard L. Peterson-San Mateo County Health Center

This article demonstrates a relationship between investor psychology and security pricing around anticipated events. Taking a multidisciplinary approach, we pull together research in the finance, psychology, and neuroscience literature. Event studies in the finance literature demonstrate anomalous security (stock, commodity, bond, or option) price movements around the dates of anticipated events. From the neuroscience literature we demonstrate correlations between reward anticipation and the arousal of affect (feelings, emotions, moods, attitudes, and preferences). From the cognitive psychology literature we extract evidence for the central role of affect in motivating investing behavior. We briefly outline an investment strategy for exploiting the event-related security price pattern described by the trading strategy "buy on the rumor and sell on the news."

Hindsight Bias and Individual Risk Attitude within the Context of Experimental Asset Markets
Tarek El-Sehity-University of Vienna
Hans Haumer-Wealth Architecture Ltd.
Christian Helmenstein-Institute for Advanced Studies
Erich Kirchler-University of Vienna
Boris Maciejovsky-Max Planck Institute for Research into Economic Systems

This paper investigates the robustness of hindsight bias in experimental asset markets, the time-invariance of the different experimental risk elicitation methods of certainty equivalents and binary lottery choices, and their correspondence. The results of our within-subject approach with 133 traders do not support the conjecture that hindsight bias is a general phenomenon. Furthermore, our findings challenge the presumption of time-stable risk preferences and of procedural invariance with respect to different experimental risk elicitation methods.

Mad Cows, Mad Corn, & Mad Money: Applying What We Know About the Perceived Risk of Technologies to the Perceived Risk of Securities
Melissa L. Finucane-Kaiser Permanente Center for Health Research, Hawaii

Thirty years of research has shown that the concept of risk in people's minds is complex and influenced by many factors. Lessons learned from studies on the perceived risk of technologies and activities (such as eating British beef or genetically modified food) are applied to the perceived risk of securities. How investors may be affected by qualitative dimensions of risk, affect and imagery, and socio-political attitudes and values, are highlighted. Specific recommendations are given for improving portfolio management with a qualitative, multi-dimensional, values-based approach that complements more traditional approaches to analysis of securities.

Research Elsewhere
Robert A. Olsen-Decision Research

Book Reviews
Robert A. Olsen-Decision Research