[Show abstract][Hide abstract] ABSTRACT: We use the daily internet search volume from millions of households to reveal market-level sentiment in real time. By aggregating the volume of queries related to household concerns (e.g. "recession", "credit card debt" and "bankruptcy"), we construct Financial and Economic Attitudes Revealed by Search (FEARS) indices as new measures of investor sentiment. Between 2004 and 2008, we …nd increases in FEARS lead to return reversals: although FEARS are associated with low returns today they predict high returns tomorrow. In the cross-section of stocks, the reversal e¤ect is strongest among stocks which are attractive to noise traders and hard to arbitrage. FEARS also predict excess volatility and daily mutual fund ow. When FEARS are high, investors are more likely to pull money out of equity mutual funds but not out of bond funds. Taken together, the results are broadly consistent with theories of investor sentiment.
[Show abstract][Hide abstract] ABSTRACT: This paper analyzes takeover announcements for public US targets from 1987 to 2008. Consistent with the hypothesis that gambling attitudes matter for takeover decisions, both acquiror announcement returns and expected synergies are lower in acquisitions where the target’s stock has characteristics similar to those of attractive gambles. Offer price premium and target announcement returns are higher in these deals. The effects are stronger in companies where managers are more entrenched, where the disciplining force of product market competition is lower, where recent acquiror performance has been poor, during economic downturns, for younger CEOs in the acquiring firm, and for acquirors headquartered in areas in which local gambling propensity is higher. Targets with lottery features are more likely to be taken over and direct evidence from hand-collected synergy disclosure data shows that the market reacts less favorably to higher synergy forecasts if they are issued in the context of a lottery acquisition. Overall, our results suggest that corporate acquisitions are influenced by managerial gambling attitudes and that value destruction for acquirors in gambling-related transactions is substantial.
[Show abstract][Hide abstract] ABSTRACT: This paper tests the hypothesis that analysts report biased earnings estimates in order to enhance their stock recommendation performance. In particular, we propose that analysts with optimistic (pessimistic) stock recommendations may issue negatively (positively) biased earn-ings forecasts so that the firm is more likely to beat (miss) the consensus forecast and experience higher (lower) stock returns. Consistent with this hypothesis, we find that stock recommenda-tions prior to earnings announcements significantly and positively predict subsequent earnings forecast errors, and that such predictability is substantially stronger when the net benefits as-sociated with such strategic behavior are larger. Moreover, while recommendation levels do not predict stock returns unconditionally, they significantly and positively predict returns around earnings announcements.
[Show abstract][Hide abstract] ABSTRACT: A substantial literature has identified systematic ways in which individuals vio-late standard economic assumptions (see Colin F. Camerer, George Loewenstein, and Matthew Rabin 2004). This literature includes both laboratory and field studies (for reviews, see Camerer 2000; Camerer, Loewenstein, and Rabin 2003; Stefano DellaVigna 2009). In spite of the extant literature documenting behavioral biases, many scholars— including some who have documented behavioral biases—remain skeptical of the claim that biases persist in markets (e.g., John A. List 2003, Steven D. Levitt and List 2008, Sergiu Hart 2005). 1 Critics of the decision bias literature believe that biases are likely to be extinguished by competition, large stakes, and experience. Levitt and List (2008) summarize their concern with the bias literature: "Perhaps the greatest challenge facing behavioral economics is demonstrating its applicability in the real world. In nearly every instance, the strongest empirical evidence in favor of behavioral anomalies emerges from the lab. Yet, there are many reasons to suspect that these laboratory findings might fail to generalize to real markets." 1 Despite the fact that List has argued that behavioral biases can be mitigated by economic markets, he has been very open to behavioral work in general (e.g., List 2002; Michael Haigh and List 2005). Although experimental studies have documented systematic decision errors, many leading scholars believe that experience, competition, and large stakes will reliably extinguish biases. We test for the pres-ence of a fundamental bias, loss aversion, in a high-stakes context: professional golfers' performance on the PGA Tour. Golf provides a natural setting to test for loss aversion because golfers are rewarded for the total number of strokes they take during a tournament, yet each individual hole has a salient reference point, par. We analyze over 2.5 million putts using precise laser measurements and find evidence that even the best golfers—including Tiger Woods—show evidence of loss aversion. (JEL D03, D81, L83) Wolfers, and seminar participants at Carnegie Mellon, the Federal Trade Commission, and The Wharton School for helpful comments and suggestions. We are also grateful to the Wharton Sports Business Initiative for generous funding. All errors are our own.
American Economic Review 03/2011; 101:129-157. · 2.69 Impact Factor
[Show abstract][Hide abstract] ABSTRACT: This paper analyzes takeover announcements from 1986 to 2008. Consistent with the hypothesis that gambling attitudes matter for takeover decisions, we find that the offer price premium is higher in acquisitions where the target's stock has characteristics similar to those of lottery tickets (high skewness, high volatility, and low price). In these lottery acquisitions both acquiror announcement returns and expected synergies are lower, while target returns are higher. The patterns we document are stronger for acquirors with poor recent performance, entrenched managers, and headquarters in areas where local gambling propensity is higher.
[Show abstract][Hide abstract] ABSTRACT: The use of past peak prices as reference points or judgmental anchors in valuing targets affects several aspects of merger and acquisition activity including offer prices, deal success, market reaction, and merger waves. Offer prices cluster at the target's recent peak prices, as well as 25% and 50% above recent peaks, even though these specific prices are fundamentally unexceptional. An offer's probability of acceptance discontinuously increases when it exceeds a peak price. Conversely, bidder shareholders react increasingly negatively as the offer price is pulled upward toward a peak price. Merger waves occur when high recent returns on the stock market and on likely targets make it easier for bidders to offer a peak price.
[Show abstract][Hide abstract] ABSTRACT: for helpful discussions. Zhen Shi and Marko Svetina provided able research assistance. Wahal is currently on leave from ASU and is employed by Dimensional Fund Advisors LP, an investment adviser registered with the Securities and Exchange Commission. This paper contains the opinions of the authors but not necessarily Dimensional or its affiliates.
[Show abstract][Hide abstract] ABSTRACT: How costly is poor governance of market intermediaries? Using a unique trade level data set from the stock market in Pakistan, we …nd that brokers when trading on their own behalf, manipulate prices and earn rates of return that are 50-90 percentage points higher than the outside investors. Neither market timing nor liquidity provision by brokers can explain the pro…tability di¤erential. Instead we …nd compelling evidence for a speci…c trade-based "pump and dump" price manipulation scheme: When prices are low, colluding brokers trade amongst themselves to arti…cially raise prices and attract positive-feedback traders. Once prices have risen, the former exit leaving the latter to su¤er the ensuing price fall. The manipulation rents extracted by brokers from such schemes therefore suggest a political economy explanation for why reforms aimed at equity market development are actively resisted by brokers.. We are extremely grateful to the Securities and Exchange Commission Pakistan (SECP) for providing us the data used in this paper, and to Mr. Khalid Mirza and Mr. Haroon Sharif for clarifying questions. The results in this paper do not necessarily represent the views of the SECP. We also thank seminar participants at Chicago GSB, LSE, MIT, LUMS, Michigan, NEUDC conference, and SECP for helpful comments and suggestions. All errors are our own.
[Show abstract][Hide abstract] ABSTRACT: The maturity of new debt issues predicts excess bond returns. When the share of long-term debt issues in total debt issues is high, future excess bond returns are low. This predictive power comes in two parts. First, inflation, the real short-term rate, and the term spread predict excess bond returns. Second, these same variables explain the long-term share, and together account for much of its own ability to predict excess bond returns. The results are consistent with survey evidence that firms use debt market conditions in an effort to determine the lowest-cost maturity at which to borrow.
Journal of Financial Economics 08/2002; 70(2). · 3.72 Impact Factor
[Show abstract][Hide abstract] ABSTRACT: Contrary to the prediction of standard portfolio diversification theory, many investors place a large fraction of their stock investment in a small number of stocks. We show that underdiversification may be a result of the solvency requirement. The key as-sumption is that investors must remain solvent after certain committed consumption at which the marginal utility is finite. We show that investors underdiversify when wealth is low and that even wealthy investors may underdiversify. In addition, vari-ance and higher moments do not affect stock selection and a less diversified stock portfolio has a higher expected return, a higher volatility, a higher skewness, and maybe a lower Sharpe ratio. Underdiversification in equilibrium implies that id-iosyncratic risks are priced. All of these theoretical predictions are consistent with empirical findings.
[Show abstract][Hide abstract] ABSTRACT: The use of the target's recent peak prices as reference points or judgmental anchors affects several aspects of merger and acquisition activity including offer prices, deal success, market reaction, and merger waves. Offer prices are biased toward the target's recent peak prices although such prices are economically unremarkable. The offer's probability of acceptance jumps discontinuously when it exceeds a peak price, a real effect of the use of peak prices. Conversely, bidder shareholders react more negatively as the offer price is influenced upward toward a peak price. Merger waves occur when high recent returns on the stock market and on likely targets make it easier for bidders to offer a peak price.
[Show abstract][Hide abstract] ABSTRACT: 2007 WFA, the 2008 ASAP, and the 2009 AFA conferences for very helpful suggestions. I am indebted to Kerry Back and Phil Dybvig for numerous discussions that have significantly improved the paper. Email: Abstract Contrary to the prediction of standard portfolio diversification theory, most investors place a large fraction of their stock investment in a small number of stocks. We show that underdiversification may be caused by risk control. The key assumption is that investors are portfolio insurers who require wealth above a nonnegative minimum level at which the marginal utility is finite (for investors whose marginal utility at zero is finite, this assumption can be replaced by the requirement of solvency). We show that investors underdiversify when wealth is low and that some investors may underdiversify no matter how wealthy they are. In addition, less wealthy and less risk-averse investors underdiversify more, and a less diversified portfolio (inclusive of the risk-free investment) is less risky than a more diversified one. Furthermore, investors select stocks solely by expected returns and covariances. Any higher mo-ments (e.g., variance and skewness) are irrelevant for this selection. In an equilibrium setting, we show that a less diversified stock portfolio has a higher expected return, a higher volatility, and maybe also a higher skewness and a lower Sharpe ratio. Finally, underdiversification in equilibrium implies that no one holds the market portfolio in equilibrium and idiosyncratic risks should be priced.
[Show abstract][Hide abstract] ABSTRACT: We propose a new and direct measure of investor attention using search frequency in Google (SVI). In a sample of Russell 3000 stocks from 2004 to 2008, we …nd that SVI (1) is correlated with but di¤erent from existing proxies of investor attention; (2) captures investor attention in a more timely fashion and (3) likely measures the attention of retail investors. An increase in SVI predicts higher stock prices in the next two weeks and an eventual price reversal within the year. It also contributes to the large …rst-day return and long-run underperformance of IPO stocks. Our results provide direct support for Barber and Odean's (2008) price pressure hypothesis and highlight the usefulness of search data which can reveal investor interests.
[Show abstract][Hide abstract] ABSTRACT: and seminar participants at Washington University in St. Louis, Rut-gers University, Yale University, and the 2007 Western Finance Association conference for very helpful suggestions. I am indebted to Kerry Back and Phil Dybvig for numerous discussions that have significantly improved the paper. All remaining errors are mine. Abstract Contrary to the prediction of the standard portfolio diversification theory, most in-vestors invest a large fraction of their stock investment in a small number of stocks and less wealthy investors invest in even fewer stocks. We provide a new and somewhat surprising explanation that it can be exactly the need for risk reduction that causes underdiversification. The two key assumptions are that investors require a nonnega-tive subsistence consumption at which the marginal utility is finite and do not buy on margin or short sell. We show that investors always underdiversify when wealth is low and investors with CRRA or mean-variance preferences may always underdiversify no matter how wealthy they are. Furthermore, investors select stocks only by expected returns and covariances, but any higher moments such as variance and skewness are irrelevant. In addition, less wealthy and less risk averse investors underdiversify more, and a less diversified portfolio (inclusive of the risk-free investment) is less risky than a more diversified one. These main results still hold in equilibrium. Moreover, our equilibrium model shows that a less diversified stock portfolio has a higher expected return, a higher volatility, and maybe also a higher skewness and a lower Sharpe ratio, all consistent with existing empirical findings. Finally, underdiversification in equilibrium implies that idiosyncratic risks can be priced.
[Show abstract][Hide abstract] ABSTRACT: The disposition effect (greater realization of winners than losers) is often taken as proof that investors have an inherent preference for realizing winners over losers. In contrast, we find that the disposition effect is not primarily driven by realization preference. The probability of selling as a function of profit is V-shaped, so that at short holding periods investors are much more likely to sell big losers than small ones. There is little indication of a jump discontinuity in selling probability at zero profits, as implied by an investor concern for the sign of realized returns. In a placebo test, there is a reverse disposition effect for the probability of buying additional shares. The speculative motive for trade potentially helps explain these findings.