Volume 5

Volume 5, Number 1, 2004 Abstracts
© Copyright Erlbaum 2004

Bleed or Blowup? Why Do We Prefer Asymmetric Payoffs?
Nassim Nicholas Taleb-New York University

The Effect of Ex Ante Price on Momentum Profits
Zhan Onayev-George Washington University
Robert Savickas-George Washington University

We find a strong effect of component stock prices (as of one year before the returns-ranking period) on the magnitude and duration of momentum. Relative strength portfolios formed of high-priced stocks earn statistically significant momentum profits for any holding period in the first three to four years. The effective annual return of the high-priced momentum portfolio for the first year is economically significant at 18.4%, after controlling for the capitalization, trading volume, and unconditional mean effects. This return is considerably higher than the 11.3% earned by low-priced momentum portfolios. Although the price level is correlated with capitalization and trading volume, the price effect is not a mere manifestation of the capitalization and volume effects, as it endures even when the other factors are controlled for. We discuss several implications of our results for the existing behavioral and risk-based explanations of momentum, as none of these models have an explicit role for the price effect.

Perceptions of Successful Traders by Foreign Exchange Professionals
Thomas Oberlechner-Harvard University and Webster University Vienna

This exploratory study examines which characteristics are perceived to be important for a successful foreign exchange trader. The findings are based on ratings by 291 professional traders at leading European banks. A factor analysis of ratings results in eight primary factors: disciplined cooperation, tackling decisions, market meaning making, emotional stability, information processing, interested integrity, autonomous organization, and handling information. Differing work location, type of foreign exchange instrument, and trading area resulted in significant differences regarding the perceived importance of these factors. Contributing to a differentiated understanding of market participants, results suggest the need for systematic job analyses of traders and may lead to more valid methods of hiring.

Identifying Heuristic Choice Rules in the Swedish Premium Pension Scheme
Ted Martin Hedesstrom-Goteborg University, Sweden
Henrik Svedsater-Goteborg University, Sweden
Tommy Garling-Goteborg University, Sweden

We analyze choices of a randomly selected sample of 10,999 citizens in the Swedish premium pension scheme. The aim is to identify the presence of various heuristic choice rules commonly observed in human decision making. Evidence suggests the prevalence of a default bias, the use of a diversification heuristic, extremeness aversion, a home bias, and the use of a 1/n heuristic. In some cases, cognitive simplification or wishful thinking may underlie the use of these heuristics. In other cases, their use seems to be consistent with recommendations provided by the responsible authority.

Adaptive Portfolio Allocation with Options
Uri Benzion-Ben-Gurion University
Ernan Haruvy-Ben-Gurion University
Tal Shavit-Ben-Gurion University

We conducted a laboratory experiment of repeated portfolio allocation choice between a bond, a stock, and a put option on the stock. The study involves two conditions: a full hedging possibility and a partial hedging possibility. Surprisingly, participants were able to converge to the mean-variance frontier in the environment with partial hedging possibilities, but were unable to do so in the full hedging condition. This suggests that subjects may not be cognizant of the mean-variance frontier. If subjects begin away from the frontier and have to adjust toward it, incentives off the frontier are critical. Simulations of adaptive dynamic models confirm this assertion. The study provides insight into the adaptive behavior of investors in the presence of hedging possibilities and implications for efficient investment strategies.

Are IPOs Priced Differently Based Upon Gender?
Nancy J. Mohan-University of Dayton
Carl R. Chen-University of Dayton

Differences between male and female management style, risk aversion, investment strategies, and financial decision making can be found in economic, management, psychology, and social literature. There are no published studies, however, linking gender issues with valuation. In this article, we consider differences in pricing female- versus male-led initial public offerings. Specifically, we find no difference in firm characteristics between a female-led and a male-led IPO, and no difference in underpricing between male-led and female-led IPOs after controlling for firm-specific variables. Our evidence suggests that in a market such as IPOs, where subjects share more similar opportunity sets, wealth, and knowledge, gender bias does not exist.

Research Elsewhere
Robert A. Olsen-California State University, Chico and Decision Research in Eugene, Oregon

Volume 5, Number 2, 2004 Abstracts
© Copyright Erlbaum 2004

The Influence of Affect on Investor Decision-Making
David Dreman-Dreman Value Management

The Influence of Different Investment Horizons on Risk Behavior
Niklas Siebenmorgen-McKinsey & Company
Martin Weber-Universitat Mannheim, Germany, and the CEPR, London

For longer investment periods, investment consultants usually recommend a larger proportion of risky assets for investor portfolios. We examine the effect of different investment horizons on investors' risk behavior. We are interested both in participants' risk perceptions and in their asset allocation behavior. We find significant underestimations of long-term risks, which lead to a higher proportion of risky assets in the long-term portfolios. Our data show that the belief in mean reversion is a potential explanation for this behavior.

Overreaction of Exchange-Traded Funds During the Bubble of 1998-2002
Jeff Madura-Florida Atlantic University
Nivine Richie-Sigmund Weis School of Business at Susquehanna University

This study of overreaction is motivated by the unique characteristics of exchange-traded funds (ETFs), which should contribute to market efficiency. Since ETFs represent portfolios of stocks, they may not be as susceptible to short-term overreaction as individual stocks. In addition, they can be traded throughout the day and can be sold short, which might further limit potential overreaction. Yet, the tradability of ETFs may allow unusual pressure on ETF prices that is not initiated by price movements of all the component stocks. We find substantial overreaction of ETFs during normal trading hours (9:30 a.m. to 4 p.m.) and after hours, which presents opportunities for feedback traders. Extreme price movements of ETFs occur more frequently after hours. Yet, the after-hours correction of extreme price movements that occurred that day is more pronounced than the day correction of extreme stock price movements that occurred in the previous after-hours period, even after controlling for ETF type and other potential confounding effects. The degree of overreaction is also more pronounced for international ETFs.

Does Mutual Fund Flow Reflect Investor Sentiment?
Daniel C. Indro-Penn State University-Great Valley

This paper examines the relationship between net aggregate equity fund flow and investor sentiment using weekly flow data. Using sentiment indicators from the American Association of Individual Investors and Investors Intelligence, I find that net aggregate equity fund flow in the current week is higher when individual investors became more bullish in the previous and current weeks. Moreover, higher net aggregate equity fund flow in the current week induces newsletter writers to become more bullish in the subsequent week. The relationship between net aggregate equity fund flow and investor sentiment remains strong even after accounting for the effects of risk premium and inflation. Overall, the evidence suggests that the behavior of equity fund investors is influenced not only by economic fundamentals, but also by investor sentiment.

Holding on to the Losers: Finnish Evidence
Mirjam Lehenkari-University of Oulu in Finland
Jukka Perttunen-University of Oulu in Finland

Recent literature reports evidence on investor behavior that is inconsistent with traditional finance theory. One currently being debated is behavioral irrationality, the tendency of investors to hold losing investments too long and sell winning investments too soon, a phenomenon known as the disposition effect. We analyze the trading records of all individual investors in the Finnish stock market and document that capital losses reduce the selling propensity of investors. There is, however, no opposite effect identifiable with respect to capital gains. We also find, somewhat surprisingly, that both positive and negative historical returns significantly reinforce the negative association between the selling propensity of investors and capital losses. While these findings offer no direct support for the disposition effect, they do suggest that investors are loss averse.

Research Elsewhere
Robert A. Olsen-California State University, Chico and Decision Research in Eugene, Oregon

Book Reviews
Robert A. Olsen-California State University, Chico and Decision Research in Eugene, Oregon

Volume 5, Number 3, 2004 Abstracts
© Copyright Erlbaum 2004

Rumors and the Financial Marketplace
Allan J. Kimmel-ESCP-EAP, European Schoolof Management, Paris

In the contemporary financial marketplace, the consequences of speculation and decision making based on unfounded assertions and false rumors can be especially potent and undeniably dangerous. With the emergence of the Internet and other new communication technologies that facilitate the spread of misinformation, it has become essential for managers, investors, and other stakeholders to acquire a better understanding of the forces that give rise to rumors and the most effective strategies for dealing with them. This paper describes how the uncertainties and anxieties generated by ambiguous situations, coupled with a strong desire for information, can frequently lead to the generation and spreading of rumors in business environments. Although relatively little research attention has been paid to the particularities of financial rumors, the author identifies some key characteristics that appear to distinguish financial rumors from rumors about other aspects of business operations, such as greater conciseness, a shorter life cycle, and the potential for significant economic consequences. The paper concludes with a set of recommendations for future research and for actions that can be taken to minimize the potentially harmful effects of financial rumors.

Projection Bias and Financial Risk Tolerance
John Grable-Department of Family Studies and Human Services at Kansas State University
Ruth Lytton-Department of Apparel, Housing and Resource Management at Virginia Tech University
Barbara O'Neill-Rutgers Cooperative Extension

Behavioral finance theories explain "why" individuals exhibit behaviors that do not maximize expected utility. This study explores how projection bias, as explained by regret theory, may shape financial risk tolerance attitudes. The results suggest that gender, income, and stock market price changes, as measured by the NASDAQ, the Dow Jones Industrial Average, and the Standard & Poor's 500 indexes, help explain risk attitudes. Risk tolerance appears to be an elastic and changeable attitude. This research expands on the work of Shefrin [2000], who reported that recent stock market price changes exert a strong influence on risk tolerance attitudes and behaviors.

Worse Than Chance? Performance and Confidence Among Professionals and Laypeople in the Stock Market
Gustaf Torngren-Stockholm University
Henry Montgomery-Stockholm University

In two studies, stock market professionals (N1 = 22, N2 = 21) and laypeople (N1 = 29, N2 = 34) provided thirty-day forecasts for twenty stocks and estimated the size of their own errors as well as their own and the other group's mean errors. Both groups predicted that the errors made by professionals would be half the size of the errors made by laypeople. In reality, the errors of both groups were about the size predicted for the laypeople. Participants also estimated their ability to pick the best performing stock from two options. Both groups proved to be overconfident. Professional predictions were only successful 40% of the time, a performance below what could be expected from chance alone. Self reports and correlations between forecasts and price movements suggested that the professionals based their predictions on specific information of the stocks without sufficient awareness of the unreliability of this information, while the laypeople used simple heuristics based on previous price movements.

Bubblelepsy: The Behavioral Wellspring of the Internet Stock Phenomenon
Aaron Bitmead-Department of Accounting and Finance at the University of Western Australia
Robert B. Durand-Department of Accounting and Finance at the University of Western Australia
Hock Guan Ng-Department of Economics at the University of Maryland Baltimore County

This paper studies daily returns of Internet stocks before and after the Internet Crash of March 27, 2000. We find evidence of a bubble before the Crash. We argue that this bubble was propelled by overconfident investors suffering from biased self-attribution. Our analysis of subgroups of Internet firms finds the stocks that were perhaps the most salient in investors' minds drove the death spiral of Internet stocks and, although the evidence is at best marginal, the entire U.S. market.

Attitudes and Trading Behavior of Stock Market Investors: A Segmentation Approach
Ryan Wood-Bayer HealthCare
Judith Lynne Zaichkowsky-H. E. C., Paris

This study identifies and characterizes segments of individual investors based on their shared investing attitudes and behavior. A behavioral finance literature review reveals five main constructs that drive investor behavior: investment horizon, confidence, control, risk attitude, and personalization of loss. Ninety individual investors were surveyed via questionnaire on these constructs. A cluster segmentation analysis identified four main segments of individual investors: 1) risk-intolerant traders; 2) confident traders; 3) loss-averse young traders; and 4) conservative long-term investors. Each segment purchased different types of stocks, used different information sources, and had different levels of trading behavior.

Research Elsewhere
Robert A. Olsen-California State University, Chico and Decision Research in Eugene, Oregon

Book Reviews
Robert A. Olsen-California State University, Chico and Decision Research in Eugene, Oregon

Editorial Commentary:
Trust, Complexity and the 1990s Market Bubble
Robert Olsen-California State University, Chico, and Decision Research

Day Traders and the Disposition Effect
Douglas Jordan-Sonoma State University
J. David Diltz-University of Texas at Arlington

The disposition effect refers to the tendency to hold losing investments and sell profitable ones. We examine day trader transactions for evidence of a disposition effect. We find that approximately 65% of sample traders hold losing trades longer than profitable ones, providing evidence that sample day traders display the disposition effect.

Measuring the Impact of Behavioral Traders on the Market for Closed-End Country Funds
Hugh Kelley-Department of Economics at Indiana University

This work investigates whether traders' state-dependent expectations biases can account for anomalous country fund discount movements. I provide a multiple-agent asset pricing model that includes both rational traders and traders who display biases in expectations formation following market states with large amounts of price variance or CNN financial news. Importantly, traders' biased behavior is based on evidence of state-dependent over- or underreaction biases observed in asset price forecasting experiments. Closed-form solutions from a multi-agent pricing model predict a multiple driver property of fund prices. Empirical tests for these drivers' influence in field data finds that up to 21% of the out-of-sample country fund discount variance can be explained by dummies representing the occurrence of behavioral bias trigger states.

Commissions Matter: The Trading Behavior of Institutional and Individual Active Traders
Ryan Garvey-A.J. Palumbo School of Business Administration and the John F. Donahue Graduate School of Business, Duquesne University
Anthony Murphy-University College Dublin, Dublin, Ireland

We examine how commissions influence trading behavior by analyzing a unique data set of the equity trades of both individual and institutional active traders. Individual traders pay higher trading costs than institutional traders. As a result, they engage in more risky trading behaviors in order to cover these costs. Individual traders also trade significantly less because of their higher cost of trading. Individual traders tend to trade higher-priced stocks, hold their trades longer, and they experience much larger price swings than institutional traders. This leads individual traders to realize more dramatic gains and losses on their round-trips.

Herding in the Italian Stock Market: A Case of Behavioral Finance
Franco Caparrelli-University of Siena in Italy
Anna Maria D'Arcangelis-University of Tuscia in Italy
Alexander Cassuto-California State University, Hayward

This article studies the herding effect in the capital markets. Using data from the Italian Stock Exchange, the authors test for the presence of herding as described in Christie and Huang [1995], Chang, Cheng, and Khorana [2000], and Hwang and Salmon [2001]. The tests support Christie and Huang's conclusions that herding is present in extreme market conditions.

Research Elsewhere
Robert A. Olsen-California State University, Chico, and Decision Research