Animal Spirits

There is a fair amount of research on clustering of prices for individual stocks and other assets near round numbers. (For examples, search the Social Science Research Network for “price clustering”.) Do closing levels of the S&P 500 Index tend to cluster near round numbers? To investigate, we count the number of daily closes for adjacent 10-point ranges of the S&P 500 Index from one centered on 500 to one centered on 1570. The first range in the sample is therefore 495-505 and the last is 1565-1575. Using all closes of the index above 495 (roughly since 1995), we find that: Keep Reading

Do sleep disruptions from switches between standard time and daylight saving time reliably affect the return on the next trading day? In their September 2009 paper entitled “The Daylight Saving Time Anomaly in Stock Returns: Fact or Fiction?”, Russell Gregory-Allen, Ben Jacobsen and Wessel Marquering revisit this question based on a much larger sample than used in prior studies. Using daily returns of stock market indexes around switches to/from daylight saving time for 22 countries around the world spanning 1966-2005 (1,150 switches, tilted toward later decades), they conclude that: Keep Reading

Two recent papers investigate the genetics of individual investing. The September 2009 paper “Nature or Nurture: What Determines Investor Behavior?” by Amir Barnea, Henrik Cronqvist and Stephan Siegel examines the degree to which genetic makeup influences individual investing behavior. The July 2009 paper “IQ and Stock Market Participation” by Mark Grinblatt, Matti Keloharju and Juhani Linnainmaa explores the relationship between intelligence and individual investing. These studies conclude that: Keep Reading

A reader observed and asked: “In the last few weeks, there have been several times when the Dow Jones Industrial Average (DJIA) was down a lot, and Asian stock markets followed it down the next day. How reliably do Asian stock markets follow sharp drops in the U.S. stock market?” To investigate, we first examine the overall relationship between the U.S. stock market (represented, as suggested, by the DJIA) and Asian stock markets (Hang Seng and Nikkei 225). Then, we focus on what happens in Asian stock markets the day after sharp drops in the U.S. market. Using daily closing levels of the DJIA, the Hang Seng index and the Nikkei 225 index for 12/31/86-8/14/09 (roughly 5800 trading days), we find that: Keep Reading

Is overreaction pervasive? Is it resistant to learning, or does experience temper it? Is overconfidence a driver of overreaction? How does overreaction affect portfolio performance? Two related July 2009 papers entitled “Overreaction in Stock Forecasts and Prices” by Alen Nosic and Martin Weber and “Overreaction and Investment Choices: An Experimental Analysis” by Bruno Biais, Alen Nosic and Martin Weber tackle these questions experimentally. Using somewhat informed university students as subjects, they conclude that: Keep Reading

How real and substantial is confirmation bias as an inhibitor of individual investor and market belief adjustments? What factors affect its impact? In their July 2009 paper entitled “Feeling Validated Versus Being Correct: A Meta-Analysis of Selective Exposure to Information”, William Hart, Dolores Albarracin, Alice Eagly, Inge Brechan, Matthew Lindberg and Lisa Merrill survey a broad selection of past research measuring the degree to which people favor information that supports pre-existing attitudes, beliefs and behaviors over information that challenges pre-existing attitudes, beliefs and behaviors. Using results from 67 reports encompassing 91 separate studies of 300 statistically independent groups comprised of nearly 8,000 participants, they conclude that: Keep Reading

Does the conventional wisdom to “sell in May,” with the average stock return during November-April far exceeding that for May-October, work for the world equity market? If so, why? In the November 2005 version of his paper entitled “The Optimism Cycle: Sell in May”, flagged by a reader, Ronald Doeswijk examines the hypothesis that this seasonal pattern derives from an annual optimism cycle. Using monthly return data for markets, sectors and Initial Public Offerings (IPO) over the period 1970 through 2003 (34 years), he concludes that: Keep Reading

Do stock traders learn rationally from past trading experience? In the March 2009 version of their paper entitled “Trading and Learning: How Different Are Different Categories of Investors?”, Sankar De, Vishal Mangla, P. Bhimasankaram and Simran Singh investigate how different categories of traders revise their beliefs about the prospects for future trading success in response to past trading experiences. Using a sample of 124 million transactions on the National Stock Exchange of India within 1.2 million accounts over the period April 2006 through June 2006, they conclude that: Keep Reading

Are the marketers right in believing that $1.99 attracts many more buyers than $2.00? In other words, do buyers irrationally fixate on the left-most digit of a price? If so, is there a way to exploit any associated stock trading tendencies? In their November 2008 paper entitled “Penny Wise, Dollar Foolish: The Left-Digit Effect in Security Trading”, Utpal Bhattacharya, Craig Holden and Stacey Jacobsen investigate the extent to which traders anchor on the left digit in stock prices. Using 100 million randomly selected stock trades during normal trading hours that are either above (buys) or below (sells) the bid-ask midpoint during 2001-2006, they conclude that: Keep Reading

In his 2008 book, Predictably Irrational: The Hidden Forces That Shape Our Decisions, behavioral economist Dan Ariely “refutes the common assumption that we behave in fundamentally rational ways.” Many of his observations have implications for investing and trading from the perspectives of avoiding irrationality as individuals and exploiting the systematic irrationalities of others. Based on his past studies of irrational behaviors, he concludes that: Keep Reading