Is more investment information always better? Are there unintended consequences for individual investors/traders acquiring investment information? Specifically, do individual investors/traders systematically acquire information to support rational future decision-making, or do they focus on information that confirms (and builds overconfidence in) decisions already made? The following two recent studies examine these questions, with results as follows:
In the September 2006 draft of their paper entitled “Acquisition of Information and Share Prices: An Empirical Investigation of Cognitive Dissonance”, Elena Argentesi, Helmut Ltkepohl and Massimo Motta investigate the relationships between return/volume/volatility for the Italian stock market and non-professional investor/trader acquisition of information, as measured by sales of the country’s principal financial newspaper. Using monthly sales of Il Sole 24Ore and concurrent Italian stock market data from 1978 to 2003, they find that:
- There is a positive correlation between stock returns and financial newspaper sales. It appears that a rising market causes non-professional investors/traders to acquire more information.
- There is no relationship between either stock trading volume or stock market volatility and newspaper sales.
- Results support a cognitive dissonance explanation of individual investor/trader behavior: “In ‘bad times’, individuals choose to be inattentive (and put their heads in the sand like ostriches), while in ‘good times’ they choose to be attentive.”
In their October 2006 paper entitled “Information Acquisition and Portfolio Performance”, Luigi Guiso and Tullio Jappelli examine the relationship between portfolio performance and investment in information by individual investors in Italy. Using a survey of randomly sampled customers of a large Italian bank that addresses investing behavior and performance in some detail, they conclude that:
- Investment in financial information increases with wealth, risk tolerance and education and decreases with the cost of information.
- Portfolio Sharpe ratio (return per unit of risk) decreases as investment in information increases, mostly because of a positive relationship between information-gathering and portfolio volatility. For example, those collecting financial information 2-4 hours per week have a Sharpe ratio 27% lower than those not collecting at all.
- This negative correlation is stronger for men and for individuals who claim they know stocks well, arguably because these groups are the most overconfident.
- Trading frequency increases, and portfolio decision delegation and diversification decrease, with investment in information.
- Overall, results support a view of investors/traders driven more by cognitive bias (represented by the lower curves on the following chart from the paper), with information amplifying overconfidence, than by rationality.
In summary, individual investors should continually ask themselves whether their information gathering efforts support rational execution of new decisions, or merely feed overconfidence in past decisions.
