Recent Developments in
Behavioral Finance
Terrance Odean
University of California, Berkeley
The 2nd Annual Conference on Personal Risk Management
The Individual Finance and Insurance Decisions
(IFID) Centre
Investor’s problem:
Choose portfolio of assets.
• Estimate probabilities (i.e., risks and rewards)
• Match with own preferences, i.e., choose.
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Estimating Probabilities
•
•
•
•
•
It happened to me.
It happened to my friends.
I can easily remember it happening.
It happened recently.
I can easily imagine how it could happen.
Habits of Individual Investors
• Trade too often.
• Hold on to losers.
• Chase the action.
2
When All Traders Are Above Average
(Odean, 1998, Journal of Finance)
• Trade more.
• Earn less.
• Underdiversify.
• Volatility increases.
• Market depth increases.
Do Investors Trade Too Much?
Odean, 1999, American Economic Review
Average Returns Following
Purchases and Sales
Stocks Bought
Minus
Stocks Sold
4 Months
Later
1 Year
Later
2 Years
Later
-1.45
-3.22
-3.57
3
Excluding Non-Speculative Trades
Average Returns Following
Speculative Purchases and Sales
4 Months 1 Year
Later
Later
Stocks Bought
Minus
Stocks Sold
-5.07
-2.46
2 Years
Later
-8.61
Trading is Hazardous to Your Wealth
Barber and Odean, 2000, Journal of Finance
Percent Annual Retur
Monthly Turnover
Monthly Turnover and Annual
Performance of Individual Investors
25
20
15
Net Return
Turnover
10
5
0
1 (Low
Turnover)
2
3
4
5 (High
Turnover)
4
Boys will be Boys
Barber and Odean, 2001, Quarterly Journal of Economics,
Percent Annual Turnover
100
80
60
40
20
0
All
Women
Single
Men
“Own Benchmark” Annual Net Returns
0
All
All Men
Women
Single Single
Women Men
-1
-2
-3
Don’t gamble ...
5
Are Investors Reluctant to Realize
Their Losses?
Journal of Finance, 1998
2.5
2
1.5
1
0.5
ec
D
ov
ct
N
ep
O
S
l
ug
Ju
A
Ja
n
Fe
b
M
ar
A
pr
M
ay
Ju
n
0
Proportion of Gains Realized / Proportion of Losses Realized
All that Glitters: The Effect of Attention
and News on the Buying Behavior of
Individual and Institutional Investors
• Thousands of stocks.
• Bounded rationality and processing ability.
• Limit search to stocks that catch attention.
• Investors buy stocks that catch their attention.
6
Individuals
• Buying
– Big search problem,
bounded rationality
(vs.)
Institutions
• Buying
– Big search problem, but many
resources
• Time to consider more stocks
• Computers to filter choice set
• Rules to determine or limit decision;
e.g., sector specific search, specific P/E
or growth criteria
• Selling
– No search problem
• Small portfolios
• Few short sales
• Selling
– Potential search problem
• Large portfolio from which to sell
• More likely to sell short than
individuals
How do individual investors solve
the search problem?
• They “limit” search to stock that catch their
attention.
• Investors don’t buy everything that catches
their attention.
• But, mostly, they buy only stocks that do.
– Contrarian
– Trend chaser
7
When do stocks attract ATTENTION?
• Abnormal volume
• Extreme price moves
• News
Abnormal Volume Sort Individuals
Imbalance by number of trades
Percent Order Imbalance .
40
Large Discount Brokerage
Large Retail Brokerage
Small Discount Brokerage
0
1
2
3
4
5
6
7
8
9
10a
10b
-40
Partitions of Stocks Sorted on Current Day's Abnormal Trading Volume
Institutions
8
Return Sort Individuals
Imbalance by number of trades
Percent Order Imbalance
30
25
Large Discount Brokerage
20
Small Discount Brokerage
15
Large Retail Brokerage
10
5
0
1a
1b
2
3
4
5
6
7
8
9
10a
10b
-5
Partitions of Stocks Sorted on Previous Day's Return
Institutions
No News vs. News
Percent Order Imbalance
Order imbalance by number of trades
20
Large Discount
Brokerage
15
10
Large Retail
Brokerage
5
0
-5
No News
News
Small Discount
Brokerage
News vs. No News
The Queen …
9
Cumulative Mean Net Purchases of IPOs
by Underpricing Category in First Month Following Offer
3.5
R<0
0≤R<10%
10%≤R<20%
20%≤R
3.0
2.0
1.5
1.0
0.5
0.0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
Trading Day
Too Many Cooks Spoil the Profits
Barber & Odean, 2000, Financial Analysts Journal
20.0
Annualized Geometric Mean (%)
Basis Points of Own
2.5
19.0
18.0
18.7
18.0 17.8
17.0
17.0
16.4
16.0
Gross
15.0
14.1
Net
14.0
13.0
12.0
11.0
10.0
Index Fund
Individuals
Clubs
10
10
39
15
2
(B
es
t)
1
3
4
5
6
7
8
10
9
7
6
4
3
3
2
9
45
40
35
30
25
20
15
10
5
0
(W
or
st)
Percentage of Buys
Mutual Funds: Money Pours into
Last Year’s Winners
Performance Decile
Online Investors:
Do the Slow Die First?
Barber and Odean, 2000
• 1,607 “early” online investors (1991-1996).
• Size-matched counterparts
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Investors who go online:
• Perform well before going online.
• Accelerate trading after going online.
• Trade more speculatively after going online,
• Perform poorly after going online.
Frictions and Self-Control
• No chocolate chip cookies in my cupboard.
12
Turnover
Annualized Turnover (%)
140%
120%
Size-Matched
100%
Online
80%
60%
40%
20%
24
20
16
8
12
4
0
-4
-8
-1
2
-1
6
-2
0
-2
4
0%
Event Month (0 is month of first online trade)
Can the biases of individual
investors affect asset prices?
• Limits of Arbitrage
• Systematic buying and selling
– Across investors
– Over time
13
Correlation of % Buys in Month t
with % Buys in Month t+L
Horizon (L): Group 1 with Group 2 with Group 1 with
Group 1
Group 2
Group 2
0
100.0%
100.0%
75.1%
56.7
58.6
55.8
45.8
46.4
45.5
39.8
40.8
41.1
36.5
34.9
36.5
1
2
3
4
Large Retail Brokerage
Evolution of Correlations (Retail)
(Table 2)
100
90
80
70
60
50
40
30
20
10
0
Group 1
Group 1 with Group 2
0
2
4
6
8
10 12 14 16 18 20 22 24
Event Month
14
Household Investments in Equity
Markets has Grown
• In 1975, 31% of household financial
assets in equities and mutual funds.
• In 1998, 61% of household financial
assets in equities and mutual funds.
Many Investors are Inexperienced
• 1995-1998, number of households
investing directly in stock grew by over
30%.
15
New Investors Learn What is Expected
of them and What to Expect from…
• Friends and family.
• Financial advisors.
• Books, magazines articles, and news.
reports.
• And advertising.
Investing Advice
from Television Commercials
Barber, Elsbach, & Odean (2002)
• Analyzed 500 television brokerage
commercials from 1990s
• Rated for advice, mood, and images
encouraging overconfidence, and illusion of
control
• Trend during 90s toward more humor, less
sound advice, and overconfidence
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Mood and Investing
• Good mood:
– more spontaneous
– more creative
– less critical decision making.
• Serious mood:
– Less spontaneous,
– more analytical,
– more critical decision making.
– Elsbach and Barr (1999); Schwarz (1999).
• Online ads: Trading is fun.
Traditional Investment Advice
•
•
•
•
•
Invest for the long run.
Buy and hold.
Diversity.
Control trading costs.
Pay attention to taxes.
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Percent of All Brokerage Commercials
Containing Selected Messages: 1990-2000
Subperiods
19901995
19962000
t-statistic
for
differences
in
subperiods
Sound financial
advice
2.65%
3.17%
1.34
Unsound financial
advice
2.65%
5.01%
1.63
Overconfidence
9.73%
24.01%
4.10
Illusion of control
2.65%
10.82%
3.04
Positive mood
12.39%
32.98%
5.11
Serious Mood
67.26%
45.65%
-5.29
What Investors Learn from Ads
• You are in control.
• Data = expertise.
• Trading is easy; anybody can do it.
• Trading is fun & exciting.
• Opportunities may arise at any moment.
Be vigilant; trade quickly and actively.
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http://faculty.haas.berkeley.edu/odean
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