Individual Investors
18 important questions on Individual Investors
Barber and Odean (2002) link experience and overconfidence
- what is it they research and what is their main finding?
- what do they find?
- what about the amount of underperformance in percentages?
Barber and Odean (2002) link experience and overconfidence:
-Investors who switch to online trading perform well prior to going online, beating the market by more than 2%.
-After going online, they trade more actively, more speculatively, and less profitably
- underperformance by more than 3% annually.
The buying decision: attention effect.
what is the attention effect?
name 4 attention drawing events
Attention effect: When buying a stock, people do not search systematically through the thousands of listed shares until they find a good “buy” and they typically buy a stock that has caught their attention.
Attention drawing events:
-Extreme past performance, whether good or bad.
-Stocks with abnormally high trading volume.
-Stocks with news announcements.
-Media coverage (Fang, Peress and Zheng, 2014).
Engelberg and Parsons (2011): Media and trading.
what are the three findings in Engelberg and Parsons ( 2011) that they find.
hint:
related to media coverage
firm size
extreme earnings surprises
Local media coverage increases local trading volume by 37% to 75%.
Larger firms experience higher turnover.
Extreme earnings surprises result in more trading activity.
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The selling decision: disposition effect
what is the dispotion effect.
Give 2 different explanations of the disposition effects and for each approach give two different reasons.
2 Behavioral explanation: Irrational belief in mean reversion. Prospect theory and mental accounting (narrow framing).
What is the prospect theory of the dispostion effect? give 2 reason whilst looking at it from the lens of prospect theory.
Gains and losses satiate: concavity and convexity of prospect theory value function.
French (2008): Development of the mutual fund industry.
what is the development that French(2008) examines?
What is a mutual fund.
Mutual fund - investment company that brings together a group of people and invests their money. Each investor owns a portion of the holdings of the fund.
Return-chasing flows of mutual fund investors Sirri and Tuffano (1998) report nonlinear performance-flow relationship:
what do Sirri and Tuffano ( 1998) report on nonlineair performance-flow relationships?
- However, the performance-flow relationship is very strong for funds whose historic performances place them in the top 20th percentile in the prior year.
Individual investors and the financial industry: Chang, Solomon and Westerfield (2016).
name 2 empirical facts on investor behavior.
Motivation Two empirical facts on investor behavior: 1 Disposition effect in direct stock holdings. 2 Return chasing behavior in mutual fund investments.
What is Cognitive dissonance.
What are two contraty cofnitions that an investor can hold?
What are two potential action that can be taken from this?
Two contrary cognitions that an investor can hold: I am a good investor and I bought this asset for a good reason. My asset has decreased in value.
Potential actions: Update one or both cognitions so they are consistent. Alter the importance of one of the cognitions. Add a new ameliorating cognition (scapegoat).
Individual investors and the financial industry: Chang, Solomon and Westerfield (2016).
What are the three hypotheses that are being tested in Chang, Solomon and WesterField ( 2016)?
Hypotheses 2: If investors experience a high level of cognitive dissonance, they will display a larger disposition effect in nondelegated assets like stocks and a larger reverse-disposition effect in delegated assets like funds.
Hypotheses 3: If investors focus more on the role of the fund manager instead of their own role, they will display a larger reverse-disposition effect.
If we look at Disposition effect in trading data.
what are three findings with respect to the disposition effect, reverse disposition effect and base probabilities that we can make?
Disposition effect in index funds. what conclusion can we draw about index funds and poor performance of such a fund?
What is the experimental setting from Chang, Solomon and Westerfield ( 2016)?
what is the motivation from Chang, Solomon and Westerfield (2016)?
Experimental setting: Story treatment – show individuals their stated reason for a buying decision. Fire treatment – increase the salience of the intermediary.
Chang, Solomon and Westerfield.(2016) what can we say about students in the story treatment and for the fire treament, what are the different results?
Experimental disposition effect for funds
Students in the Fire treatment displayed a significantly larger reverse-disposition effect, consistent with the cognitive dissonance hypothesis.
Students in the Story treatment also displayed a significantly greater reverse-disposition effect.
What doe the story treatment do to the magnitude of the disposition effect?
In Frazzini and Lamont (2008)..
what are the two hypothesis that are being tested aswell as what do these two hypothesis entail?
1 Smart money hypothesis:
Some mutual fund managers have skill and some individual investors can detect that skill, and send their money to skilled managers.
2 Dumb money hypothesis:
Individual investors cannot detect skill of mutual fund managers. Mutual fund flows measure individual investor sentiment for different stocks, and high sentiment predicts low future returns.
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