Behavioral Finance II
Paper Session
Sunday, Jan. 8, 2017 3:15 PM – 5:15 PM
Sheraton Grand Chicago, Sheraton Ballroom IV
- Chair: David Solomon, University of Southern California
Do Individual Behavioral Biases Affect Financial Markets and the Macroeconomy?
Abstract
A common criticism of behavioral economics is that it has not shown that the psychological biases of individual investors lead to aggregate long-run effects on both asset prices and macroeconomic quantities. Our objective is to address this criticism by providing a simple example of a production economy where individual portfolio biases cancel when summed across investors, but still have an effect on aggregate quantities that does not vanish in the long-run. Specifically, we solve in closed form a model of a stochastic general-equilibrium production economy with a large number of heterogeneous firms and investors. Investors in our model are averse to ambiguity and so hold portfolios biased toward familiar assets. We specify this bias to be unsystematic so it cancels out when aggregated across investors. However, because of holding underdiver- sified portfolios, investors bear more risk than necessary, which distorts the consumption of all investors in the same direction. Hence, distortions in consumption do not cancel out in the aggregate and therefore increase the price of risk and distort aggregate investment and growth. The increased risk from holding biased portfolios, which increases the demand for the risk-free asset, leading to a higher equity risk premium and a lower risk-free rate that match the values observed empirically. Furthermore, all investors survive in the long-run, and so the effects of their biases never vanish. Our analysis illustrates that idiosyncratic behavioral biases can have long-run distortionary effects on both financial markets and the macroeconomy.Why Don't We Agree? Evidence From a Social Network of Investors
Abstract
We study the sources of investor disagreement using sentiment expressed by investors on a social media investing platform, combined with information on the users' investment approaches (e.g., technical, fundamental). We examine how much of overall disagreement is driven by different information sets versus differential interpretation of the same information, by studying disagreement within and across investment approaches. We find that differences of opinion across investment approaches account for 47.7 percent of the overall disagreement at the firm-day level. Moreover, changes in our measures of disagreement robustly forecast abnormal trading volume, suggesting that our measures proxy well for disagreement in the wider market. Our findings suggest that improvements to informational efficiency of financial markets by regulators will not completely erode high trading volume and stock market volatility.The Speed of Communication
Abstract
Drawing from research on disease contagion, we estimate a transmission matrix to quantify how the speed at which information (or noise) travels through the investor population varies with distances in social characteristics (such as age, income, and gender). We utilize cross-industry stock-financed mergers and acquisitions as a source of plausibly exogenous variation in investors’ information-gathering activity. In particular, we conjecture that, once “infected” with shares of an acquiring firm, target investors are more likely to study and trade in an acquirer industry; target investors also spread any newly acquired industry views to their neighbors. Tracing the path of contagion via investors’ trading behavior, we estimate that, regarding any relevant investor pair, a ten-year difference in age, a one-step difference in income, and being of different genders lowers the effective communication rate between the investor pair by 12%, 2%, and 17%, respectively. In addition, the effective communication rate from older, wealthier, female investors to their younger, poorer, male counterparts is noticeably higher than the effective communication rate that runs in the reverse direction.Discussant(s)
Karl Diether
, Brigham Young University
Aydogan Alti
, University of Texas-Austin
Joseph Engelberg
, University of California-San Diego
Matti Keloharju
, Aalto University
JEL Classifications
- G1 - Asset Markets and Pricing