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Market Efficiency in an Irrational World
Abstract
This paper explains why investors are likely to be overconfident and how this behavioral bias affects investment decisions. Our analysis suggests that investor overconfidence can potentially generate stock return momentum and that this momentum effect is likely to be the strongest in those stocks whose valuation requires the interpretation of ambiguous information. Consistent with this, we find that momentum effects are stronger for growth stocks than value stocks. A portfolio strategy based on this hypothesis generates strong abnormal returns that do not appear to be attributable to risk. Although these results violate the traditional efficient markets hypothesis, they do not necessarily imply that rational but uniformed investors, without the benefit of hindsight, could have actually achieved the returns. We argue that to examine whether unexploited profit opportunities exist, one must test for what we call adaptive-efficiency, which is a somewhat weaker form of market efficiency that allows for the appearance of profit opportunities in historical data, but requires these profit opportunities to dissipate when they become apparent. Our tests reject this notion of adaptive-efficiency.
... Similarly, Shapira and Venezia (2001) found the presence of a disposition effect in the investment decisions of professional investors and individual investors. Furthermore, Daniel and Titman (1999) identified the presence of overconfidence bias among investors can lead to momentum in stock returns. Kahneman et al. (2011) argued that executives, over time, build decision processes that can help in the reduction of the effect of behavioural biases and enhance the value of investment returns. ...
... Trading performance, disposition effect, overconfidence, representativeness bias, and experience of emerging market investors 250 Daniel and Titman (1999) Market Efficiency in an Irrational World 167 ...
... Cluster 5 comprises 23 articles focusing on Momentum, overreaction, and investment performance, which have accumulated a total of 3,237 citations. Daniel et al. (1998), Chen et al. (2007), and Daniel and Titman (1999), with 2396, 250, and 167 citations, are the top three cited articles, respectively. Daniel et al. (1998) explained the association between overconfidence bias, self-attribution bias, and excess volatility. ...
Behavioural finance combines psychology and economics to understand the anomalies of financial markets by examining human behaviour. There has been a significant global increase in research on behavioural biases and investment decisions. This paper aims to conduct a bibliometric analysis of behavioural biases and investment decisions using literature from the Scopus database for the period from 1991 to 2022 using the VOSviewer software. The research findings confirm a substantial growth in research on behavioural biases and investment decisions between 2008 and 2022. The United States is the most influential country based on citation count, and Odean (1998) stands out as the most prominent author in this research field. Co-citation analysis identifies key clusters in "efficient market, behavioural biases, and trading frequency," while bibliographic coupling highlights "Information processing and investors' behavioural biases." Co-occurrence analysis reveals gaps in research on financial literacy, personality traits, and optimism bias, suggesting future research opportunities.
... As a result, consumers who do not have relevant shopping experiences cannot control all the information about the products. Therefore, they will collect those who have experience in purchasing or using as a reference before making purchase decisions (Spencer, 1996;Daniel and Titman, 1999;Steinhart et al., 2014;Xu and Warkentin, 2020). Daniel and Titman (1999) took the stock investment market as a research context and suggested that investors are easily influenced by the opinions of others to follow the herd when they are in an environment with insufficient information. ...
... Therefore, they will collect those who have experience in purchasing or using as a reference before making purchase decisions (Spencer, 1996;Daniel and Titman, 1999;Steinhart et al., 2014;Xu and Warkentin, 2020). Daniel and Titman (1999) took the stock investment market as a research context and suggested that investors are easily influenced by the opinions of others to follow the herd when they are in an environment with insufficient information. This shows that the professionalism and reliability of a leader in the field can easily lead to the emergence of conformity. ...
Purpose: This paper mainly focuses on the perfume products as research objective and aims to investigate the relationship between personality traits, conformity, perception of perfume’s usefulness and purchase intention. Theoretical framework: With the rapid growth on economic development, consumers’ awareness of perfume is gradually increasing. Numerous customers are beginning to have an interest in perfume products and willing to purchase them. Design/methodology/approach: This study explores consumers who have an interest in perfume products as research object and collects a total of 176 valid questionnaires by surveying. Findings: Through statistical analysis, these results suggest that consumer’s personality traits directly affect the perception of perfume’s usefulness, as well as their purchase intention. Research, Practical & Social implications: This study concludes that conformity has a significant influence on the purchase intention. Originality/value: Recent trends in preference for perfume even higher than other similar products such as cosmetics products or beauty care products. However, far too little attention has been paid to perfume products.
... The Pearson correlation results was the main item. According to Daniel and Titman (2019) Pearson correlation analysis indicates the strength, direction, and significance of bivariate relationship among the variables. To establish the correlation between information processing bias sub-variables and investment decision of equity investors at Nairobi Securities Exchange NSE) the results are presented in Table 2. Table 2. Correlation matrix of information processing bias sub-variables and investment decision. ...
The goal of the study was to established the influence of information processing bias on investment decision of equity investors at Nairobi Securities Exchange. The study improved the existing finance literature, which increased the body of general knowledge. Researchers and aspiring academics would utilize the findings as a future source of reference for expanding their understanding of behavioral finance. This study employed regret aversion theory, descriptive research design applied in this research and the stratified random sampling technique. In this study, primary data was also employed. SPSS version 26 (Statistical Package for Social Science) was used for data analysis. Descriptive, correlation as well as regression analysis were undertaken and outcome was offered in tables followed by pertinent interpretation and discussion. The most influential variable was Market’s competition-related information with a regression coefficient of 0.502 (p-value = 0.027) and lastly Product’s market potential-information with a coefficient of 0.403 (p-value = 0.041). The study concludes that information processing bias holds a significant and influential role in shaping investment decisions among equity investors at the Nairobi Securities Exchange. Thus, it can be concluded that understanding and leveraging product market potential can positively impact investment decisions. It is crucial for investors to carefully assess market competition dynamics to maximize investment returns. This study also implies that by analyzing investor behavior, company management Can further evaluate capital markets' performance of stocks and adjust policies and strategies appropriately.
... With the enhanced ability of the LPLM to nonlinearly map text features, some studies have started to explore the use of multisource text data, including individual investor comments, for stock price prediction (Wu et al., 2022). However, compared to news professionalism, individual investors possess typical irrational characteristics (Daniel & Titman, 1999). It is still under exploration whether the textual information they post on social media can reflect market fluctuations. ...
Stock price prediction has always been a difficult task for forecasters. Using cutting-edge deep learning techniques, stock price prediction based on investor sentiment extracted from online forums has become feasible. We propose a novel hybrid deep learning framework for predicting stock prices. The framework leverages the XLNET model to analyze the sentiment conveyed in user posts on online forums, combines these sentiments with the post popularity factor to compute daily group sentiments, and integrates this information with stock technical indicators into an improved BiLSTM-highway model for stock price prediction. Through a series of comparative experiments involving four stocks on the Chinese stock market, it is demonstrated that the hybrid framework effectively predicts stock prices. This study reveals the necessity of analyzing investors' textual views for stock price prediction.
... The third strand is the no difference hypothesis. While the classical efficient capital market theory (Fama, 1970) questions whether any abnormal returns can ever be generated by using public information, the adaptive efficient capital market theory (Daniel & Titman, 1999) suggests that any abnormal returns based on trading strategies via public information will dissipate over time (Bebchuk et al., 2013). So, any value proposition-whether in the form of ethical and/or religious values-will not affect stock prices. ...
Sustainable investing and Islamic finance have been two of the fastest-growing areas of finance. In Islamic finance, equity markets play an important role. In the literature on Islamic equities, there are relatively few studies that have integrated sustainability factors into Islamic finance. In this paper, our objective is to contribute to the line of research on the integration of sustainable investing into Islamic finance. To that end, we first examine the comparative performance of investing in the sustainability indices from those Organization of Islamic Cooperation (OIC) countries that are partners of the Sustainable Stock Exchanges (SSE) initiative. We then conduct a case study of Borsa Istanbul in Turkey, which has the best-performing sustainability index from OIC countries. Overall, our findings reveal the heterogeneity in sustainable investment performance, and suggest the potential of obtaining superior risk-adjusted returns in certain economies from OIC countries. This study draws implication on how sustainable investing can help bridge the gap between Islamic and conventional financial markets.
... The possible explanation for the high and significant (at 5%) coefficient for one year could be the underpricing of the stocks in the short term. It may happen for various reasons, such as herd behaviour (Hirshleifer & Teoh, 2003) or irrational trading (Daniel & Titman, 1999) due to news. However, once the following year's results are disclosed, the stocks' valuations are adjusted upward, increasing their FPP efficiency. ...
This paper measures the degree to which disclosed annual financial information assimilates into stock prices through the financial production process (FPP). Since it is established that price anchors impact investor trading decisions, the effect of proximity to chosen price anchors and the historical high and low prices on FPP efficiency is analysed for 611 Indian firms across 11 industries. Results show that a significant number of stocks are FPP inefficient, and the FPP efficiency is mean-reverting. Further, FPP efficiencies depend on proximity to price anchors, implying that FPP efficiency is a proxy measure of behavioural bias in stock prices.
... The irrationality of investors, market friction, and incomplete arbitrage represent violations of the EMH (Daniel & Titman, 1999). In empirical terms, many financial anomalies are evident in financial markets such as long-range dependency (Giacalone & Panarello, 2022;Lo, 1991;Urquhart & Hudson, 2013), higher peak and fat tail (Enders, 1995;Fama, 1965;Wu et al., 2021), volatility clustering (Bae et al., 2020;Peters, 2015), and multifractal (Mandelbrot, 1971;Mandelbrot et al., 1997;Zhang & Fang, 2021). ...
This paper adopts the fractal analysis approach, specifically a Hurst exponent index in portfolio optimization at the Damascus Securities Exchange (DSE). We construct three portfolios based on the Hurst index from stocks listed on the DSE during the period between 2019 and 2021 and find that these portfolios outperform the market portfolio in terms of returns, Sharpe ratio, Treynor ratio, and alpha. In addition, selecting stocks with high Hurst coefficients further enhances the performance of the portfolio. Importantly, even in out-of-sample tests, the three fractal portfolios continue to outperform the market portfolio. Furthermore, we find that fractal portfolios outperform portfolios formed using the momentum and size strategies demonstrating the superiority of the fractal analysis approach. We conclude that the incorporation of fractal analysis into the portfolio optimization problem allows the creation of a more efficient portfolio. Hence, we recommend that investors consider the Hurst exponent index in their portfolio optimization for better investment decisions.
... Fama and French's (1993) model extends Carhart's (1997) model. Sharpe (1964), Mossin (1966), Fama and French (1993), and Daniel and Titman (1999) added the Momentum factor in 1993 as described by Sharpe (1964), alongside the CAPM used by Carhart (1997). Investing in momentum means choosing stocks that have performed well and are likely to do so in the future. ...
The purpose of this study is to review the empirical work applied to market efficiency, portfolio selection and asset valuation, focusing on the presentation of the comprehensive theoretical framework of Information Entropy Theory (IET). In addition, we examine how entropy addresses the shortcomings of traditional models for valuing financial assets, including the market efficiency hypothesis, the capital asset pricing model (CAPM), and the Black and Scholes option pricing model. We thoroughly reviewed the literature from 1948 to 2022 to achieve our objectives, including well-known asset pricing models and prominent research on information entropy theory. Our results show that portfolio managers are particularly attracted to valuations and strive to achieve maximum returns with minimal risk. The entropy-based portfolio selection model outperforms the standard model when return distributions are non-Gaussian, providing more comprehensive information about asset and distribution probabilities while emphasising the diversification principle. This distribution is then linked to the entropic interpretation of the no-arbitrage principle, especially when extreme fluctuations are considered, making it preferable to the Gaussian distribution for asset valuation. This study draws important conclusions from its extensive analysis. First, entropy better captures diversification effects than variance, as entropy measures diversification effects more generically than variance. Second, mutual information and conditional entropy provide reasonable estimates of systematic and specific risk in the linear equilibrium model. Third, entropy can be used to model non-linear dependencies in stock return time series, outperforming beta in predictability. Finally, information entropy theory is strengthened by empirical validation and alignment with financial views. Our findings enhance the understanding of market efficiency, portfolio selection and asset pricing for investors and decision-makers. Using Information Entropy Theory as a theoretical framework, this study sheds new light on its effectiveness in resolving some of the limitations in traditional asset valuation models, generating valuable insights into the theoretical framework of the theory.
... Avramov et al. (2007) and Garlappi and Yan (2011) show that momentum profits are stronger for highly distressed firms and firms with low credit rating; the credit distress puzzle is that these firms also have anomalously low returns. Daniel and Titman (1999) and Sagi and Seasholes (2007) show that momentum profits are stronger for growth firms and high growth option firms; the value premium puzzle is that these firms also have anomalously low returns. Bandarchuk and Hilscher (2013) show that momentum profits are stronger for more volatile firms; the IVOL puzzle is that these firms have anomalously low returns. ...
We uncover a link between momentum and overvaluation: assets that generate strong momentum profits have lower risk-adjusted unconditional returns, conversely, trading momentum within overvalued assets doubles the profit of the standard momentum strategy. We compute the profits of a momentum strategy within various portfolios; portfolios within which momentum is profitable are defined as momentum trading opportunity (MTO). High MTO assets have negative unconditional alphas and concentrate in the short legs of most anomalies; controlling for MTO reduces anomaly alphas by up to half. These results imply that the existence of other anomalies is closely linked to the existence of momentum and they should be studied jointly.
... Self-attribution bias refers to the inclination of investors to attribute investment success in their portfolio to their own skill, while external variables are to blame for investment failures (Hoffmann & Post, 2014). Overconfidence bias can be developed over a period because of selfattribution bias (Barber & Odean, 2000;Billett & Qian, 2008;Chevalier & Ellison, 1999;Daniel et al., 1998;Daniel & Titman, 1999;Gervais & Odean, 2001;Lalwani & Duval, 2000;Mishra & Metilda, 2015;. Personal market volatility, aggressive trading and excessive risk taking are some of the visible characteristics associated with this bias (Baginski et al., 2000;Gervais & Odean, 2001) 2.1.7. ...
Responses from 480 Indian respondents, 240 each investing in Mutual Funds and Exchange Traded Funds were studied to assess individual investors behavioral biases with the help of factors of herding, market, prospect, overconfidence and availability bias by using one way MANOVA approach. Results indicate that the Mutual Fund (active investment) investors show significantly higher behavioral biases as compared to Exchange Traded Fund (passive investment) investors in emerging markets. Behavioral biases effect on investments has been extensively studied on individual products, but this article is the first attempt to make comparative analysis of behavioral biases on active and passive investments. Behavioral biases have received little attention in the developing markets and results of this paper have practical implications for policymakers in understanding the dynamic behavior of the active and passive investors and educate the investors for proper investment decisions.
... A first approach to the adaptive market conjecture and its validation was carried out by Daniel and Titman (1999), who discuss why investors are likely to be overconfident and how that behavioral bias affects their investment decisions. To examine whether unexploited profit opportunities exist, the authors tested for a "somewhat" weak form of market efficiency, also called adaptive efficiency, which allows for the appearance of profit opportunities in historical data. ...
This article examines the adaptive market hypothesis in the five most important Latin American stock indices. To that end, we apply three versions of the variance ratio test, as well as the Brock-Dechert-Scheinkman test for nonlinear predictability. Additionally, we perform the Dominguez-Lobato and generalized spectral tests to evaluate the Martingale difference hypothesis. Moreover, we consider salient news related to the plausible market inefficiencies detected by these four tests. Finally, we apply a GARCH-M model to assess the risk-return relationship through time. Our results suggest that the predictability of stock returns varies over time. Furthermore, the efficiency in each market behaves differently over time. All in all, the analyzed emerging market indices satisfy the adaptive market hypothesis, given the switching behavior between periods of efficiencies and inefficiencies, since the adaptive market hypothesis suggests that market efficiency and market anomalies might coexist in capital markets.
... The study can be further expanded to understand if the individuals with dark triad personalities also experience the cycle of market emotion and its impact on financial decisions. Alternatively, Daniel and Titman (1999) note that irrational investors have little impact on market movements. On the contrary, they observe that traders and arbitrageurs are rational and have more impact on the market. ...
Environmental concerns are top priorities for all nations in the globe today. Organisations must thus address these problems given the ongoing pressure on them to take action that is environmentally friendly. One industry that has a negative impact on the environment is logistics. Logistics activities have greatly risen as a result of globalisation. The logistics market will reach USD 6,300 billion on a global scale by 2024, with a compound annual growth rate of 4.9% from 2019 to 2024. In order to improve the environment and reduce carbon emissions, manufacturing companies are implementing new strategies and green regulations. Green logistics has recently gained popularity in wealthy nations. Despite being in developing nations, it is still in its early stages and requires more attention. The lack of promotion and adoption of green techniques in logistics by developing nations had been questioned. For the Indian manufacturing sector, the current study focuses on green logistics drivers, challenges, practices and performance metrics (especially in the oil and gas sector). Because it is a well-known industry that generates a significant amount of carbon emissions, the oil and gas sector was chosen for the research study. This industry’s downward vertical includes the main logistics functions, such as marketing and wholesaling and has never been centred on green logistics. The implementation of the green logistics practices is governed by a number of drivers and barriers that both enable its implementation and may serve as obstacles. These factors must be thoroughly explored because they are the most important ones. This study’s main goal is to provide a conceptual framework for green logistics that will apply to the logistics activities carried out by the Indian manufacturing industry (oil and gas) and the impact they have on economic and environmental performance. In the context of the oil and gas industry, the key green logistics drivers that could facilitate the adoption of green logistics practises have been thoroughly researched. By outlining the finest green logistics methods and factors that the sector should take into account, this study is further developed. The officials and managers who work for the downward logistics of the oil and gas industry were selected for the study and the survey questionnaire was employed as the research tool. Finally, using structural equation modelling, the effects of these green logistics practises on economic and environmental performance have also been researched and examined (SEM). When developing various rules and incentives for the Indian manufacturing sector to encourage the adoption of green logistics practices, this report would be crucial for the government. The results of this study about various green logistics activities may be related to creating a long-term plan for the industrial sector. The research will be helpful to future researchers, practising managers, governmental organisations, academic institutions and the Indian manufacturing industry as a whole.
... The study can be further expanded to understand if the individuals with dark triad personalities also experience the cycle of market emotion and its impact on financial decisions. Alternatively, Daniel and Titman (1999) note that irrational investors have little impact on market movements. On the contrary, they observe that traders and arbitrageurs are rational and have more impact on the market. ...
Over the last two decades, the behavioural finance literature has extensively relied on personality type to explain the non-rational behaviour of investors. This study considers Dark triad (Machiavellianism, narcissism and psychopathy) to explain its influences on investment preference and perceived success in investment. A primary survey was conducted on 227 individuals who invest in securities. Dark triad was measured using 27 items Short Triad Scale (SD3). The data were analyzed using multinomial logistic regression. The investment preference was evaluated by asking the respondents about their preferred investment avenues, individuals were asked how they evaluate their investment success. Personality variables were grouped into high, average and low based on the mean responses to the items under each variable. The results of the study indicate that individuals with low and average levels of psychopathy and low-level narcissism preferred investing only in mutual funds, bonds and equity. It was also found that Machiavellianism, narcissism, psychopathy and dark triad, all have a significant impact on investment preference. The dark triad also significantly impacted success, especially for those individuals who perceived their investment strategy as ‘Very Successful’. This study helps financial advisors to suggest appropriate portfolios or investment avenues based on their personalities.
... This high self-confidence will determine whether or not the individual will take a high-risk choice (Tokar, 2015). High self-confidence can also affect individuals in making investment decisions (Daniel and Titman, 2006). ...
The COVID-19 pandemic has increased people's expenses, so good knowledge in managing finances is needed. The millennial generation is one of the community groups known to be consumptive and have a low level of financial literacy. Whether or not financial management is good is based on the level of community financial literacy. That indicates that the better people's financial literacy, the better they will manage finances. Financial literacy consists of financial behavior, financial attitude, financial knowledge, and financial confidence. Therefore, this study examines the relationship between financial attitude, financial knowledge, and financial confidence in financial behavior. This study also establishes a comprehensive financial literacy model to increase financial literacy during the COVID-19 pandemic. Lastly, this study contributes to the literature developing a financial literacy model for millennials in small towns. This study involved 146 respondents from the millennial generation in Rembang City. Testing was carried out using SEM GeSCA. The results indicated that the factors that directly affect financial behavior are financial attitude and financial confidence. Financial knowledge was found to influence financial behavior indirectly. However, the study results revealed that financial knowledge does not directly affect financial behavior. Future studies can add new variables with a larger sample to obtain more general results.
... For instance, Taylor and Brown (1994) have found that positive illusions lead to "higher motivation, greater persistence, more effective performance, and ultimately greater success. " Daniel and Titman (1999) argued that overconfidence was a trait that likely arose through evolutionary selection. They believed that a trait such as overconfidence would be eliminated through natural selection if it simply resulted in irrational decisions. ...
Overconfidence behavior, one form of positive illusion, has drawn considerable attention throughout history because it is viewed as the main reason for many crises. Investors’ overconfidence, which can be observed as overtrading following positive returns, may lead to inefficiencies in stock markets. To the best of our knowledge, this is the first study to examine the presence of investor overconfidence by employing an artificial intelligence technique and a nonlinear approach to impulse responses to analyze the impact of different return regimes on the overconfidence attitude. We examine whether investors in an emerging stock market (Borsa Istanbul) exhibit overconfidence behavior using a feed-forward, neural network, nonlinear Granger causality test and nonlinear impulse-response functions based on local projections. These are the first applications in the relevant literature due to the novelty of these models in forecasting high-dimensional, multivariate time series. The results obtained from distinguishing between the different market regimes to analyze the responses of trading volume to return shocks contradict those in the literature, which is the key contribution of the study. The empirical findings imply that overconfidence behavior exhibits asymmetries in different return regimes and is persistent during the 20-day forecasting horizon. Overconfidence is more persistent in the low- than in the high-return regime. In the negative interest-rate period, a high-return regime induces overconfidence behavior, whereas in the positive interest-rate period, a low-return regime induces overconfidence behavior. Based on the empirical findings, investors should be aware that portfolio gains may result in losses depending on aggressive and excessive trading strategies, particularly in low-return regimes.
... However, in the presence of irrational investors, the errors identified would be revised by the arbitration mechanism, leading to the maintenance of the fundamental value. These investors focus on the relevance of public information circulating on the market to their private information held by other economic agents and the calculation of the incorporation speed and integration of data into the price of securities (Daniel and Titman, 1999). From a behavioral viewpoint, the decisions of individuals are possibly biased by emotions, sensations, heuristics, and mental states. ...
This study analyses and compares the behavior of the gold-backed, conventional cryptocurrency, and gold markets capable of detecting the existence of herding and deducing the efficiency degree. In addition, this empirical work tried to examine the COVID-19 pandemic's influence on both cryptocurrency performances. This work developed a new method that discloses herding biases using persistence and efficiency metrics. Besides, this paper investigated the nonlinear dynamic properties of the gold-backed, conventional cryptocurrencies and Gold by estimating the Multifractal Detrended Fluctuation Analysis (MFDFA). It also assessed the inefficiency of these markets through an efficiency index (IEI) and tested the effect of COVID-19 on their dynamics. The findings of this investigation indicate that the gold-backed cryptocurrency (X8X) is the most efficient market in the long-term trading market. However, the conventional cryptocurrency market (Bitcoin) is the most efficient on the short trade horizon. Besides, gold-backed cryptocurrency markets present a smaller level of herding behavior than conventional cryptocurrencies on tall scales. Nevertheless, we noted the positive and negative effects of the pandemic on each cryptocurrency market dynamics. To the best of the authors' knowledge, this study is the first investigation that uses multifractal analysis to quantify the impact of the COVID-19 spread on gold-backed cryptocurrencies and detects the presence of herding behavior.
... Sin embargo, también se plantea una hipótesis más flexible, "que dice que los precios reflejan información hasta el punto en que los beneficios marginales de actuar sobre la información (las ganancias que se obtienen) no exceden los costos marginales" (Jensen, 1978citado por Fama, 1991. Así las cosas, con fundamento en la hipótesis de los mercados financieros eficientes, únicamente con el acceso a información privilegiada es posible obtener rendimientos excepcionales al operar en los mercados financieros; por lo que, "si un inversionista no tiene información especial, no importará lo inteligente que sea, no podrá mejorar el rendimiento de su portafolio de inversión" (Daniel & Titman, 1999). ...
his work aims to explore the theory of efficient financial markets, under an analysis framework based on the assumption of rationality of the agents. For this purpose, it starts from an analysis of the theoretical considerations and the practical implications in the operation of the stock market analysis and investment decision making. Then, based on a documentary review, a discussion is opened around the problematizing question: Are financial markets efficient? The starting point is the approach to the efficiency levels proposed by Fama (1970) in order, based on these, to free the discussion around the empirical evidence of some studies or cases given in practice, with which serious questions are raised. to this theoretical approach. In the end, some considerations are raised from the perspective of behavioral finance, where feelings, emotionsand collective behavior patterns can explain certain anomalies in the markets
... Value and momentum are natural complements in the equity factor-investing literature (Asness 1997;Daniel & Titman 1999;Fisher et al. 2014) owing to its negative correlations (Asness et al. 2013). Another strand of literature also looks at momentum within value (Pani & Fabozzi 2021) which is an enhancement of value by combining its timeseries and cross-sectional properties. ...
Equity markets are amongst the most researched areas in asset pricing literature. Data availability and the liquid and transparent nature of equity markets have aided research in this domain. The research on corporate bond markets is considerably less due to both the illiquid and over-the-counter (OTC) nature of these markets which have resulted in less easy availability of reliable data sources. Corporate bond and equities possess commonalities in their behaviour largely because of being at different points in the capital structure of firms. Indeed, adverse news for a company should adversely affect the pricing of both the firm’s equity and debt. As a result, practitioners often consider corporate bonds as a combination of government-bonds and beta-adjusted equities used as a proxy for credit exposure. In the thesis however, we seek to demonstrate that credit risk, although highly correlated in the short term, can be different from equity risk. The seminal work on the pricing of corporate debt was by Robert Merton (Merton 1974). The Merton model represented corporate debt as the combination of a risk-free asset and a short position in a put option on the assets of the firm. Equity was represented as a long call option on the assets of the firm. Since then models such as Black and Cox (1976) and Leland (1994) have extended the Merton model but the key features of corporate bond pricing and its co-movement with equity prices are still well represented by the Merton model. The Merton model, while capturing a point of commonality – the common effect of changes in asset prices to equity and debt price – and a key difference – the left-tailed nature of corporate debt returns – does not address other key areas of differences between the two asset classes. One area of difference, studied extensively in the empirical literature, but not in structural models is the significant difference in liquidity and trading dynamics between the two markets. Another key area of difference between the two markets comes from the differing type of investors. Regulations, which are much more onerous for corporate debt than equities, can lead to non-market-driven behaviour such as a significant aversion to downgrades. The goal of my PhD thesis is to study the commonality and differences between these two asset classes and Its implication on the cross-section of corporate bond returns. Specifically, we look at three aspects of differences between corporate and equities. The first chapter focuses on the issuance of corporate bonds and contrasts with equity issuance. It starts with the issuance process and analyses the new issue premiums in corporate bonds contrasting it with results seen in equity initial public offerings (IPOs). This chapter also analyses the determinants of corporate bond issuance concessions. The second chapter looks at the short-term commonalities and differences between the performance patterns of corporate bonds and equities. This chapter merges two distinct branches of literature on structural credit models and commonalities in corporate bond-equity behaviour with that of cross-asset momentum. The last two chapters focus on the topical area of exchange traded funds and their dislocations, as measured by the significant deviations between prices and net-asset-values (NAV), seen in this market during the extreme volatility at the peak of the Covid-19 crisis in March 2020. Specifically in chapter 4, we study the dislocation in fixed-income and specifically corporate bond ETFs and contrast it with the relatively better-behaved equity ETFs. We show that this relative dislocation is not just from liquidity differences and that the ETF price may have been an over-reaction. In chapter 5, we build a model for ETF arbitrage specifically taking into account incentives of the arbitrageurs, a critical difference between fixed income and equity ETFs. We show that inventory management by dual market makers and arbitrageurs may have exacerbated the dislocation.
... To the extent that our mechanism partly drives the momentum and long-term reversal effects for unconstrained stocks, these effects should be more muted for low-disagreement shocks. Consistent with this hypothesis, compelling evidence indicates that momentum is stronger in high-disagreement (Lee and Swaminathan 2000;Verardo 2009;Zhang 2006), and in low-quality or difficult-to-value information environments (Cohen and Lou 2012;Daniel and Titman 1999;Hong, Lim, and Stein 2000). ...
In this paper, we infer how the estimates of firm value by “optimists” and “pessimists” evolve in response to information shocks. Specifically, we examine returns and disagreement measures for portfolios of short-sale-constrained stocks that have experienced large gains or large losses. Our analysis suggests the presence of two groups, one of which overreacts to new information and remains biased over about 5 years, and a second group, which underreacts and whose expectations are unbiased after about 1 year. Our results have implications for the belief dynamics that underlie the momentum and long-term reversal effect.
Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
Financa e ndërmarrjes ka si objekt studimin e kontratave financiare dhe investimeve që rezultojnë nga ndërveprimi i drejtuesve dhe investuesve të një kompanie. Një shpjegim i plotë i modeleve të financimit dhe investimit kërkon për këtë arsye një kuptim të qartë të perceptimeve dhe preferencave të këtyre dy grupeve agjentësh ekonomikë. Shumica e kërkimeve në fushën e financave të ndërmarrjes ngrihen mbi supozimet se këto perceptime dhe preferenca janë plotësisht racionale. Agjentët ekonomikë supozohen se realizojnë parashikime të paanshme në lidhje me ngjarjet e ardhshme dhe mbështeten në këto parashikime për të marrë vendimet që u shërbejnë më së miri interesave të tyre. Kjo nënkupton që drejtuesit e një kompanie mund të marrin për të mirëqenë se tregjet e kapitalit janë eficientë, me çmime që pasqyrojnë në mënyrë të arsyeshme informacion publik në lidhje me vlerat themelore. Në të njëjtën mënyrë, investuesit e një kompanie mund të marrin për të mirëqenë se drejtuesit do të veprojnë në interesin e tyre, duke iu përgjigjur në mënyrë racionale stimujve të kompensimit, të kontrollit dhe mekanizmave të tjerë të qeverisjes së korporatave.
This chapter examines herding behaviour in investors that affect the financial market. Herding involves investors mimicking others' actions due to factors like limited information, market sentiments, and psychological biases. Individual investors, less informed and more susceptible to emotions, herd more. Drawing from Buddhist economics, financial mindfulness emerges as a crucial intervention to mitigate herding. It promotes awareness of one's financial situation, enhancing independent decision-making and reducing impulsive behaviour. Empirical evidence supports mindfulness-based interventions in improving financial decisions and managing debt effectively. By cultivating a thoughtful approach to finance, financial mindfulness empowers investors to resist herd behaviour, fostering stability in financial markets.
Although momentum exists in many markets throughout the world, explanations for momentum have largely been tested using U.S. data. We investigate the extent to which U.S.-based momentum explanations extend to the international context, using regression-based and portfolio approaches. Amongst the several hypotheses we consider, we find reliable support for the hypothesis that because of limited attention, investors underreact to information arriving in small bits rather than in large chunks, which results in momentum. We also find secondary support for the overconfidence hypothesis for momentum. Finally, we find that momentum is stronger in up-markets and less-volatile markets in the international context just as in the U.S. This finding also accords with the investor overconfidence hypothesis, under the proviso that investors are more confident in rising, low-volatility markets.
In the rapidly growing world of sustainable finance, emerging markets saw a recent surge in their market share, which underscored the increasing investor appetite for environmental, social, and governance (ESG) products. In the literature on sustainable investing, most studies have focused on developed markets, and there are relatively few studies that have concentrated on emerging markets. To fill this research gap, we study sustainable investing in emerging markets, by examining the comparative performance of the sustainability indices in the partner exchanges of the Sustainable Stock Exchanges (SSE) initiative from emerging markets. In particular, we investigate three key issues that are of concern to most investors: (i) can the investment strategy of investing together in the themes of sustainability and emerging markets outperform the global sustainability benchmark? (ii) can this strategy outperform the global benchmark for emerging markets? (iii) can it improve portfolio diversification? Overall, our time series analysis and Monte Carlo simulation reveal the heterogeneity in sustainable investment performance across the world, and suggest the potential of obtaining superior risk‐adjusted returns in certain regions while benefiting from portfolio diversification.
In the capital market, people suffer from many biases, which causes the emergence of irrational behaviors. For this reason, people are often exposed to a significant level of risk; to get rid of it, they behave like others. Based on this, the aim of this research is to answer the question "Does the loss aversion scam have a significant effect on the formation of herding behavior among the investors of the Tehran Stock Exchange?". To achieve this goal, an online analytical questionnaire with 411 investors was designed to collect primary data, and multiple regression analysis was used to analyze and interpret the data. The findings of this research show that loss aversion has a positive and significant effect on herding behavior and one of the reasons for such behavior among investors is that people who are loss averse always try to model herding behavior, assuming that others feel the same way as themselves. On the other hand, the results showed that those who rely on their own knowledge also show herding behavior, especially when people learn about the knowledge of others, they rely more on their perceived knowledge, and herding behavior gains strength. Another result indicates that investors who see their performance as high have the same performance as others and follow the behavior of others in the market.
This study employs data from the Taiwan stock market to demonstrate the potential for capitalizing upon the momentum eect by exploiting the Almost Stochastic Dominance rules. Relative to classic momentum, our novel strategy achieves better risk-adjusted performance, and exhibits lower volatility and reduced negative skewness in returns. The abnormal returns are statistically and economically signicant when testing against alternative common risk factors. Most interestingly, the strategy's ability to generate excess returns is particularly pronounced when using shorter-term ranking and holding periods. Notable improvements in computational eciency suggest that practical implementability of the strategy shall prevail in cases where a large span of assets is considered.
The study assesses based on the responses from the survey of 342 persons how behavioural biases affect German investors' investment decisions. Three behavioural biases were examined: overconfidence, representativeness, and herding behavior. It was determined that demographic factors affecting German investors, such as gender, age, experience, education, and frequency of investment, influence this choice. Male German investors are more susceptible to all three biases than females. Young investors (<35 years) are more at risk for the overconfidence bias and the representativeness bias, while older investors (>35 years) are more at risk for the herding bias. Investors with a lower experience (<5 years) on the stock market have a higher tendency for the three biases than German investors with a higher experience (> five years). Investors with a high (i.e. university) education are more susceptible to the three biases than those with a low education. Investors with a high investing frequency (> three months) scored higher for all three biases than investors with a low investing frequency (<3 months).
Behavioral finance deals with the behavioral and psychological consequences of financial decisions. Investors are characterized in traditional finance as rational individuals who aim to maximize their benefits. The behavioral finance approach claims that this is not always applicable. According to this approach, individual investors are impacted by various psychological biases and tendencies while making financial decisions. In this context, the conditions based on the effective market theory established by traditional finance cannot be always provided. In this study, it is investigated whether individual investors residing in Istanbul have psychological biases and tendencies such as overconfidence, confirmation, hindsight, conservatism, availability, loss-aversion, familiarity, mental accounting, regret aversion, ambiguity aversion, and herd behavior while making investment decisions. In the empirical part of the study, these eleven biases and tendencies are considered dependent variables; the differences between those who have economics/finance education and those who do not are examined within this framework. In this context, the main purpose of the study is to determine whether there are any impacts on individual investors who have economics/finance education and who do not in their avoidance of these biases and tendencies. To achieve this goal, a questionnaire study has been applied to 434 individual investors residing in Istanbul, and the data obtained has been analysed and interpreted using the SPSS 26.0 statistical program. As a result of the analysis, only regret aversion bias differs between investors who have studied and have not studied economics/finance, according to the statistics. In terms of all other biases and tendencies, having an economics/finance education does not appear to make a difference for the surveyed group.
This study finds that the predictability of economic policy uncertainty on short-term reversals is stronger among stocks exposed more to the volatility index (VIX) and economic policy uncertainty index (EPU). In addition, the predictability of VIX on short-term reversals is stronger among stocks exposed more to this index and the Aruoba–Diebold–Scotti business conditions index (ADS). Furthermore, the finding is robust after controlling for the other popular investor sentiment indexes, the Fama–French five risk factors, financial crises, and firm size.
Über die letzten Jahre, insbesondere auch über das erste Jahr der weltweiten Corona-Pandemie hinweg, wurde weltweit ein drastischer Anstieg an Investoren an den Börsen der Welt vermerkt. Dieses internationale Phänomen konnte im Besonderen auch bei einer speziellen Altersgruppe identifiziert werden, welche auf das Börsenparkett drängte. Es handelt sich hierbei um junge Investoren der Generationen der Millennials sowie der Generation Z, der sog. Generation "Invest". In jenen Altersgruppen der 18 bis 35-jährigen wurde allein in Deutschland ein Anstieg um fast 50% Prozent verzeichnet. Im Rahmen der fortschreitenden Digitalisierung und der Normalisierung der Informationssuche durch das Internet sowie der aktiven Nutzung von sozialen Netzwerken im Alltag steht mit dem Drang an die Börse über die letzten Jahre ein weiteres Phänomen in Einklang. Dieses stellt eine Ausprägung des Influencer-Geschäfts dar, welches insbesondere über die sozialen Medien hinweg einen großen Einfluss auf die Konsum-und Investitionsentscheidungen von Privatpersonen ausübt. Es entstanden sehr viele Konten von sog. Finanz-Influencern auf sozialen Netzwerken, welche einen rasanten Anstieg verzeichneten und auf ein sehr großes Interesse bei den Nutzern dieser Netzwerke trafen.
Behavioural finance contradicts the notion of perfect rationality and identifies cognitive and emotional factors and their impact on investment decision-making. Behavioural finance theories are more focused in understanding the cognitive, social, and emotional biases of investors and to analyse how these biases influence the market prices, returns, and allocation of resources. Behavioural finance is a novel area that examines investor decision-making processes in order to better understand anomalies, or deviations. Investors may be inclined toward various types of behavioural biases, which lead them to make cognitive errors. The paper examines impact of behavioural biases on investment decision-making. Specifically, the study considers herding, heuristics, prospect theory, familiarity, overconfidence, representativeness in making investment decision. The study found that there is impact of these behavioural biases on investment decision-making and there is significant relationship between these biases.
Private investors’ underperformance compared to institutional investors is attributed to a combination of factors, including home bias and overconfidence bias. Home bias refers to the tendency of private investors to overinvest in their domestic markets, which can result in missed opportunities for diversification and exposure to international markets. Institutional investors are less likely to exhibit this bias as they have the resources and expertise to invest globally. Overconfidence bias, on the other hand, refers to private investors’ tendency to believe they have an informational advantage and can outperform the market. This can lead to excessive trading and suboptimal investment decisions. Institutional investors, with their experience and disciplined investment processes, are less likely to fall prey to overconfidence bias. Together, these biases contribute to the underperformance of private investors compared to institutional investors. The following abstract presents four strategies to overcome home- and overconfidence bias derived from the insights of this literature reviewed meta analysis.
There are various behavioral aspects that influence the financial decisions of individual investors, such as overconfidence, herding behavior, loss aversion, and regret aversion. Other psychological elements may play a substantial influence in deciding the success or failure of any financial action. The primary aims of the present research article are to examine the effects of overconfidence bias and herding behavior on individual financial decisions regarding crypto currency investment. The markets for crypto currencies are extremely sensitive to any minute or significant changes in the economy, as well as to any changes in the individual behaviors of investors. To achieve these aims, 650 questionnaires were distributed to individual investors employed by various financial institutions, multinational corporations, including oil and gas exploration and production companies, operating in Pakistan, individual investors dealing in stocks, and students regardless of investment size. Purposive sampling was used to choose 311 valid responses from a total of 593. Those investors that engage in crypto currency investments were deemed valid responses. Classifications of investments were outlined, and demographic information was requested from respondents. SPSS-based empirical analysis provided the basis for the conclusions. The primary findings indicate that both overconfidence bias and herding tendency have a favorable and statistically significant impact on investors' financial decisions when investing in cryptocurrencies. In this study's sample, however, the majority of investors were overconfident in their crypto currency investing decisions.
Geleneksel finans teorileri finansal piyasalarda finansal yatırımcının her zaman rasyonel davrandığını, yatırım kararlarında getirisini maksimize edecek kararlar verdiğini, tam bilgiye sahip olduğunu, piyasada işlem maliyetlerinin olmadığını varsaymaktadır. Piyasalarda tüm bilgi finansal varlık fiyatlarına hızla yansımakta, varlık fiyatları gerçek değerini yansıtmakta, normalin üzerinde getiri fırsatı oluşmamaktadır. Bu piyasa etkinliğiyle tanımlanmakta ve Etkin Piyasalar Hipotezi ile açıklanmaktadır. Fakat geleneksel teoriler piyasalardaki finansal yatırımcıların yatırım kararları nedeniyle oluşan anormal varlık fiyatlarını açıklamakta yetersiz kalmaktadır. Bu nedenle açıklanmakta güçlük çekilen finansal krizler, fiyat anomalileri yatırımcı davranışını da dikkate alan davranışsal finans yaklaşımıyla daha iyi açıklanmaya çalışılmaktadır. Çalışmada BIST30 Endeks getirisinden hesaplanan ±4 standart sapma değerleri ile tespit edilen örneklem olarak seçilen haberlerin BIST30 Endeks pay senetleri yatırımcısı üzerindeki etkileri Olay Analizi Yöntemi ile araştırılmaktadır. Analiz sonuçları BIST30 Endeksinde haber etkisi sonucu anormal getiri oluştuğunu ve piyasanın yarı güçlü formda etkin olmadığını göstermektedir. BIST30 Endeks pay senetlerinde olumlu haber etkisi sonrası negatif trend başlarken, olumsuz haber etkisi sonrasında ise pozitif trend başlamaktadır. Ayrıca demografik olarak Isparta ilindeki yatırımcı verileri analiz edildiğinde 40 yaş altı daha çok sayıdaki yatırımcı, daha küçük değerdeki portföylerle piyasada işlem yaparken, 40 yaş üstü daha az sayıdaki yatırımcı daha büyük portföylerle yatırım yapmayı tercih etmektedir.
The financial markets have been suffering from unforeseen and sudden economic turbulences that have been directly or indirectly influences the assets values. To analyze such these market influences, the separate discipline, investment management was formed in Finance and developed chronologically up to current professional and scientific phase. It is the fact that the market has been stimulated by the financial indicators which is in number as well as by the behavioral characteristics of the investment communities. Moreover, while considering the financial market as the mirror of economy it is equally important to note that the market moves on the sentiments and the trading behavior of the market participants. In the meantime, the trading behaviors depend upon the market information such as financial and non-financial - media, politics, hypes, etc. The study analyzes the market information and stock returns in Nepalese context in 2012. The study primarily focus on the usefulness of the historical database, the financial news coverage and its effects on stock returns, the political leadership effects on stock returns, and the study also determine the factors of investment decision.
Özellikle son elli yıl içerisinde, davranışsal finans alanı genel olarak finans literatüründe son derece önem kazanmıştır. Finansal piyasaları doğrudan etkilemesi sebebiyle, bireysel yatırımcıların finansal anlamda karar ve davranış mekanizmalarını şekillendiren faktörlerin incelenmesi oldukça önemli hale gelmiştir. Geleneksel finansal yaklaşımdan farklı olarak, davranışsal finans alanı yatırımcıların irrasyonel olduğunu varsaymaktadır. Bu davranışsal finans yaklaşımının getirilmesi ile, bireylerin finansal yatırım kararlarında nasıl ve ne şekilde rasyonel olmaktan uzaklaştıkları anlaşılmaya çalışılmıştır. Yatırımcıların irrasyonel davranışlarının bazıları bilişsel önyargılar ve hevristikler başlıkları altında şekillenmiştir. Bu çalışmada, yatırımcı davranışları bilişsel önyargılar ve hevristikler başlıkları altında ve kavramsal çerçevede incelenmiştir.
People who hold strong opinions on complex social issues are likely to examine relevant empirical evidence in a biased manner. They are apt to accept "confirming" evidence at face value while subjecting "disconfirming" evidence to critical evaluation, and, as a result, draw undue support for their initial positions from mixed or random empirical findings. Thus, the result of exposing contending factions in a social dispute to an identical body of relevant empirical evidence may be not a narrowing of disagreement but rather an increase in polarization. To test these assumptions, 48 undergraduates supporting and opposing capital punishment were exposed to 2 purported studies, one seemingly confirming and one seemingly disconfirming their existing beliefs about the deterrent efficacy of the death penalty. As predicted, both proponents and opponents of capital punishment rated those results and procedures that confirmed their own beliefs to be the more convincing and probative ones, and they reported corresponding shifts in their beliefs as the various results and procedures were presented. The net effect of such evaluations and opinion shifts was the postulated increase in attitude polarization. (28 ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
The pattern of overconfidence and underconfidence observed in studies of intuitive judgment is explained by the hypothesis that people focus on the strength or extremeness of the available evidence (e.g., the warmth of a letter or the size of an effect) with insufficient regard for its weight or credence (e.g., the credibility of the writer or the size of the sample). This mode of judgment yields overconfidence when strength is high and weight is low, and underconfidence when strength is low and weight is high. We first demonstrate this phenomenon in a chance setup where strength is defined by sample proportion and weight is defined by sample size, and then extend the analysis to more complex evidential problems, including general knowledge questions and predicting the behavior of self and of others. We propose that people's confidence is determined by the balance of arguments for and against the competing hypotheses, with insufficient regard for the weight of the evidence. We show that this account can explain the effect of item difficulty on overconfidence, and we relate the observed discrepancy between confidence judgments and frequency estimates to the illusion of validity. Finally, we contrast the present account with a frequentistic model of confidence proposed by Gigerenzer and his colleagues, and present data that refute their model.
Predictable variation in equity returns might reflect either (1) predictable changes in expected returns or (2) market inefficiency
and stock price “overreaction.” These explanations can be distinguished by examining returns over short time intervals since
systematic changes in fundamental valuation over intervals like a week should not occur in efficient markets. The evidence
suggests that the “winners” and “losers” one week experience sizeable return reversals the next week in a way that reflects
apparent arbitrage profits which persist after corrections for bid-ask spreads and plausible transactions costs. This probably
reflects inefficiency in the market for liquidity around large price changes.
If returns on some stocks systematically lead or lag those of others, a portfolio strategy that sells “winners” and buys “losers”
can produce positive expected returns, even if no stock’s returns are negatively autocorrelated as virtually all models of
overreaction imply. Using a particular contrarian strategy we show that, despite negative autocorrelation in individual stock
returns, weekly portfolio returns are strongly positively autocorrelated and are the result of important cross-autocorrelations.
We find that the returns of large stocks lead those of smaller stocks, and we present evidence against overreaction as the
only source of contrarian profits.
We examine whether the predictability of future returns from past returns is due to the market's underreaction to information, in particular to past earnings news. Past return and past earnings surprise each predict large drifts in future returns after controlling for the other. Market risk, size, and book-to-market effects do not explain the drifts. There is little evidence of subsequent reversals in the returns of stocks with high price and earnings momentum. Security analysts' earnings forecasts also respond sluggishly to past news, especially in the case of stocks with the worst past performance. The results suggest a market that responds only gradually to new information. Copyright 1996 by American Finance Association.
This paper documents that strategies that buy stocks that have performed well in the past and sell stocks that hav e performed poorly in the past generate significant positive returns o ver three- to twelve-month holding periods. The authors find that the profitability of these strategies are not due to their systematic risk or to delay ed stock price reactions to common factors. However, part of the abnorm al returns generated in the first year after portfolio formation dissipates in the following two years. A similar pattern of returns around the earnings announcements of past winners and losers is also documented. Copyright 1993 by American Finance Association.
This article develops and applies new measures of portfolio performance which use benchmarks based on the characteristics of stocks held by the portfolios that are evaluated. Specifically, the benchmarks are constructed from the returns of 125 passive portfolios that are matched with stocks held in the evaluated portfolio on the basis of the market capitalization, book‐to‐market, and prior‐year return characteristics of those stocks. Based on these benchmarks, “Characteristic Timing” and “Characteristic Selectivity” measures are developed that detect, respectively, whether portfolio managers successfully time their portfolio weightings on these characteristics and whether managers can select stocks that outperform the average stock having the same characteristics. We apply these measures to a new database of mutual fund holdings covering over 2500 equity funds from 1975 to 1994. Our results show that mutual funds, particularly aggressive‐growth funds, exhibit some selectivity ability, but that funds exhibit no characteristic timing ability.
Recent empirical research in finance has uncovered two families of pervasive regularities: underreaction of stock prices to news such as earnings announcements, and overreaction of stock prices to a series of good or bad news. In this paper, we present a parsimonious model of investor sentiment, or of how investors form beliefs, which is consistent with the empirical findings. The model is based on psychological evidence and produces both underreaction and overreaction for a wide range of parameter values.
Value and momentum strategies both have demonstrated power to predict the cross- section of stock returns, but are these strategies related? Measures of momentum and value are negatively correlated across stocks, yet each is positively related to the cross-section of average stock returns. We examine whether the marginal power of value or momentum differs depending upon the level of the other variable. Value strategies work, in general, but are strongest among low-momentum (loser) stocks and weakest among high-momentum (winner) stocks. The momentum strategy works, in general, but is particularly strong among low-value (expensive) stocks. These results hold despite finding comparable spreads in value measures among stocks with different levels of momentum and comparable spreads in the momentum measure among stocks with different levels of value. Any explanation for why value and momentum work must explain this interaction.
Most discussions of the cost of investing in equity mutual funds focus on one component of cost, the expense ratio, and ignore another significant cost, sales loads. As a result, conclusions about the total cost of mutual fund investing have often been incomplete or misleading. This paper analyzes trends in the cost of investing in equity mutual funds from 1980 to 1997 using a measure called "total shareholder cost." This measure includes all major costs of investing in a mutual fund and is comparable to the fee and expense information required by the U.S. Securities and Exchange Commission in the mutual fund prospectus. The paper finds that the average cost of invest- ing in equity mutual funds has dropped by more than one-third since 1980. The paper also finds evidence of economies of scale among equity funds.
The possibility of resampling (bootstrapping) a spatial pattern is investigated. It is suggested that resampling provides a unified approach to consistemt inference in a wide range of coverage problems. Nevertheless, resampling distorts some of the interactions in the problem, and so introduces biases. The sizes of bias and standard deviation are investigated in the case of estimating sampling variance via resampling.
This paper identifies five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors, related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, and they are linked to bond returns through shared variation in the bond-market factors. Except for low-grade corporates, the bond-market factors capture the common variation in bond returns. Most important, the five factors seem to explain average returns on stocks and bonds.
Research on this project was supported by a grant from the National Science Foundation. I am indebted to Arthur Laffer, Robert Aliber, Ray Ball, Michael Jensen, James Lorie, Merton Miller, Charles Nelson, Richard Roll, William Taylor, and Ross Watts for their helpful comments.
Bibliography: leaves 53-56. Robert C. Merton.
The authors show how to use security market data to restrict the admissible region for means and standard deviations of intertemporal marginal rates of substitution of consumers. Their approach (1) is nonparametric and applies to a rich class of models of dynamic economics; (2) characterizes the duality between the mean-standard deviation frontier for intertemporal marginal rates of substitution and the familiar mean-standard deviation frontier for asset returns; and (3) exploits the restriction that intertemporal marginal rates of substitution are positive random variables. The region provides a convenient summary of the sense in which asset market data are anomalous from the vantage point of intertemporal asset pricing theory. Copyright 1991 by University of Chicago Press.
The authors present a model of portfolio allocation by noise traders with incorrect expectations about return variances. For such misperceptions, noise traders who do not affect prices can earn higher expected returns than rational investors with similar risk aversion. Moreover, such noise traders can come to dominate the market in that the probability that they eventually have a high share of total wealth is close to one. Noise traders come to dominate despite their taking of excessive risk and their higher consumption. The authors conclude that the case against their long-run viability is not as clear-cut as is commonly supposed. Coauthors are Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann. Copyright 1991 by University of Chicago Press.
The value premium in U.S. stocks returns is robust. The positive relation between average return and book-to-market equity (BE/ME) is as strong for 1929-63 as for the subsequent period studied in previous papers. Like others, we also find a size premium in stock returns. Small stocks have higher average returns than big stocks. The size premium is, however, weaker and less reliable than the value premium. The relations between average return and firm characteristics (size and BE/ME) are better explained by a three-factor risk model than by the behavioral hypothesis that investor overreaction causes characteristics to be compensated irrespective of risk loadings.
The asymptotic distributions of cointegration tests are approximated using the Gamma distribution. The tests considered are for the I(1), the conditional I(1), as well as the I(2) model. Formulae for the parameters of the Gamma distributions are derived from response surfaces. The resulting approximation is flexible, easy to implement and more accurate than the standard tables previously published.
We develop a multiperiod market model describing both the process by which traders learn about their ability and how a bias in this learning can create overconfident traders. A trader in our model initially does not know his own ability. He infers this ability from his successes and failures. In assessing his ability the trader takes too much credit for his successes. This leads him to become overconfident. A trader's expected level of overconfidence increases in the early stages of his career. Then, with more experience, he comes to better recognize his own ability. The patterns in trading volume, expected profits, price volatility, and expected prices resulting from this endogenous overconfidence are analyzed. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
Corruption in the public sector erodes tax compliance and leads to higher tax evasion. Moreover, corrupt public officials abuse their public power to extort bribes from the private agents. In both types of interaction with the public sector, the private agents are bound to face uncertainty with respect to their disposable incomes. To analyse effects of this uncertainty, a stochastic dynamic growth model with the public sector is examined. It is shown that deterministic excessive red tape and corruption deteriorate the growth potential through income redistribution and public sector inefficiencies. Most importantly, it is demonstrated that the increase in corruption via higher uncertainty exerts adverse effects on capital accumulation, thus leading to lower growth rates.
Sample evidence about the predictability of monthly stock returns is considered from the perspective of a risk-averse Bayesian investor who must allocate funds between stocks and cash. The investor uses the sample evidence to update prior beliefs about the parameters in a regression of stock returns on a set of predictive variables. The regression relation can seem weak when described by usual statistical measures but the current values of the predictive variables can exert a substantial influence on the investor's portfolio decision, even when the investor's prior beliefs are weighted against predictability. Copyright 1996 by American Finance Association.
Recent empirical research in finance has uncovered two families of pervasive regularities: underreaction of stock prices to news such as earnings announcements, and overreaction of stock prices to a series of good or bad news. In this paper, we present a parsimonious model of investor sentiment, or of how investors form beliefs, which is consistent with the empirical findings. The model is based on psychological evidence and produces both underreaction and overreaction for a wide range of parameter values.
Firm sizes and book-to-market ratios are both highly correlated with the average returns of common stocks. Eugene F. Fama and Kenneth R. French (1993) argue that the association between these characteristics and returns arise because the characteristics are proxies for nondiversifiable factor risk. In contrast, the evidence in this article indicates that the return premia on small capitalization and high book-to-market stocks does not arise because of the comovements of these stocks with pervasive factors. It is the characteristics rather than the covariance structure of returns that appear to explain the cross-sectional variation in stock returns. Copyright 1997 by American Finance Association.
International equity markets exhibit medium-term return continuation. Between 1980 and 1995 an internationally diversified portfolio of past medium-term Winners outperforms a portfolio of medium-term Losers after correcting for risk by more than 1 percent per month. Return continuation is present in all twelve sample countries and lasts on average for about one year. Return continuation is negatively related to firm size, but is not limited to small firms. The international momentum returns are correlated with those of the United States which suggests that exposure to a common factor may drive the profitability of momentum strategies. Copyright The American Finance Association 1998.
Using a sample free of survivor bias, the author demonstrates that common factors in stock returns and investment expenses almost completely explain persistence in equity mutual funds' mean and risk-adjusted returns. Darryll Hendricks, Jayendu Patel, and Richard Zeckhauser's (1993) 'hot hands' result is mostly driven by the one-year momentum effect of Narasimham Jegadeesh and Sheridan Titman (1993), but individual funds do not earn higher returns from following the momentum strategy in stocks. The only significant persistence not explained is concentrated in strong underperformance by the worst-return mutual funds. The results do not support the existence of skilled or informed mutual fund portfolio managers. Copyright 1997 by American Finance Association.
Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital and is typically risky. Moreover, professional arbitrage is conducted by a relatively small number of highly specialized investors using other people's capital. Such professional arbitrage has a number of interesting implications for security pricing, including the possibility that arbitrage becomes ineffective in extreme circumstances when prices diverge far from fundamental values. The model also suggests where anomalies in financial markets are likely to appear, and why arbitrage fails to eliminate them. Copyright 1997 by American Finance Association.
Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market "beta", size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in "beta" that is unrelated to size, t he relation between market "beta" and average return is flat, even when "beta" is the only explanatory variable. Copyright 1992 by American Finance Association.
We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. Copyright The American Finance Association 1998.
This paper derives two main results. First, in a world where inheritance is sexual as opposed to asexual, second-best adaptations can be evolutionarily stable. That is, the adaptation selected need not be the optimal solution to the evolutionary problem at hand. Second, the author applies this result to show that natural selection provides a potential explanation for why, in many settings, humans commit errors that are systematic in nature. Copyright 1994 by American Economic Association.
: We model a market populated by two groups of boundedly rational agents: "newswatchers" and "momentum traders". Each newswatcher observes some private information, but fails to extract other newswatchers' information from prices. If information diffuses gradually across the population, prices underreact in the short run. The underreaction means that the momentum traders can profit by trend-chasing. However, if they can only implement simple (i.e., univariate) strategies, their attempts at arbitrage must inevitably lead to overreaction at long horizons. In addition to providing a unified account of under- and overreactions, the model generates several other distinctive implications. * Stanford Business School and MIT Sloan School of Management and NBER. This research is supported by the National Science Foundation and the Finance Research Center at MIT. We are grateful to Denis Gromb, Ren Stulz, an anonymous referee, and seminar participants at MIT, Michigan, Wharton, Duke, UCLA, Berk...
We examine how the evidence of predictabilityinasset returns a#ects optimal portfolio choice for investors with long horizons. Particular attention is paid to estimation risk, or uncertainty about the true values of model parameters. We #nd that even after incorporating parameter uncertainty, there is enough predictability in returns to make investors allocate substantially more to stocks, the longer their horizon. Moreover, the weak statistical signi#cance of the evidence for predictability makes it important to take estimation risk into account; a long-horizon investor who ignores it mayover-allocate to stocks by a sizeable amount. # Graduate School of Business, University of Chicago. I am indebted to John Campbell and Gary Chamberlain for guidance and encouragement. I also thank an anonymous referee, the editor Ren#e Stulz, and seminar participants at Harvard, the Wharton School, Chicago Business School, the Sloan School at MIT, UCLA, Rochester, NYU, Columbia, Stanford, IN...
This study shows that past trading volume provides an important link between "momentum" and "value" strategies. Specifically, we find that firms with high (low) past turnover ratios exhibit many glamour (value) characteristics, earn lower (higher) future returns, and have consistently more negative (positive) earnings surprises over the next eight quarters. Past trading volume also predicts both the magnitude and persistence of price momentum. Specifically, price momentum effects reverse over the next five years and high (low) volume winners (losers) experience faster reversals. Collectively, our findings show that past volume helps to reconcile intermediate-horizon "underreaction" and long-horizon "overreaction" effects. 1 Financial academics and practitioners have long recognized that past trading volume may provide valuable information about a security. However, there is little agreement on how volume information should be handled and interpreted. Even less is known about how past...
: Various theories have been proposed to explain momentum in stock returns. We test the gradual-information-diffusion modelofHong and Stein (1999) and establish three key results. First, once one moves past the very smallest stocks, the profitability of momentum strategies declines sharply with firm size. Second, holding size fixed, momentum strategies work better among stocks with low analyst coverage. Finally, the effect of analyst coverage is greater for stocks that are past losers than for past winners. These findings are consistent with the hypothesis that firm-specific information, especially negative information, diffuses only gradually across the investing public. * Hong is from the Stanford Business School, Lim is from the AmosTuck School, Dartmouth College, and Stein is from the MIT Sloan School of Management and the National Bureau of Economic Research. This research is supported by the National Science Foundation and the Finance Research Center at MIT. We are grateful to J...
Psychological studies establish that people are usually overconfident and that they systematically overweight some types of information while underweighting others. How overconfidence affects a financial market depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price-taking traders, a strategic-trading insider, and risk-averse market-makers are overconfident. It also analyzes the effects of overconfidence when information is costly. In all scenarios, overconfidence increases expected trading volume and market depth while lowering the expected utility of those who are overconfident. However, its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, or highly relevant information, while they overreact to salient, anecdotal, or less relevant information.
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