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Abstract:
We test and confirm the hypothesis that individual investors are net buyers of attention-grabbing stocks, e.g., stocks in the news, stocks experiencing high abnormal trading volume, and stocks with extreme one day returns. Attention-driven buying results from the difficulty that investors have searching the thousands of stocks they can potentially buy. Individual investors don't face the same search problem when selling because they tend to sell only stocks they already own. We hypothesize that many investors only consider purchasing stocks that have first caught their attention. Thus, preferences determine choices after attention has determined the choice set.

attention, news, investor behavior, individual investors, behavioral finance, behavioral biases

Abstract:
We study the trading behavior of individual investors using the Trade and Quotes (TAQ) and Institute for the Study of Security Markets (ISSM) transaction data over the period 1983 to 2001. We document four results: (1) Order imbalance based on buyer- and sellerinitiated small trades from the TAQ/ISSM data correlates well with the order imbalance based on trades of individual investors from brokerage firm data. This indicates trade size is a reasonable proxy for the trading of individual investors. (2) Order imbalance based on TAQ/ISSM data indicates strong herding by individual investors. Individual investors predominantly buy (sell) the same stocks as each other contemporaneously. Furthermore, they predominantly buy (sell) the same stocks one week (month) as they did the previous week (month). (3) When measured over one year, the imbalance between purchases and sales of each stock by individual investors forecasts cross-sectional stock returns the subsequent year. Stocks heavily bought by individuals one year underperform stocks heavily sold by 4.4 percentage points in the following year. For stocks for which it is most difficult to arbitrage mispricings, the spread in returns between stocks bought and stocks sold is 13.1 percentage points the following year. (4) Over shorter periods such as a week or a month, a different pattern emerges. Stocks heavily bought by individual investors one week earn strong returns in the subsequent week, while stocks heavily sold one week earn poor returns in the subsequent week. This pattern persists for a total of three to four weeks and then reverses for the subsequent several weeks. In addition to examining the ability of small trades to forecast returns, we also look at the predictive value of large trades. In striking contrast to our small trade results, we find that stocks heavily purchased with large trades one week earn poor returns in the subsequent week, while stocks heavily sold one week earn strong returns in the subsequent week.

Behavioral Finance, Asset Pricing, Market Efficiency

Abstract:
Modern financial economics assumes that we behave with extreme rationality but we do not. Furthermore, our deviations from rationality are often systematic. Behavioral finance relaxes the traditional assumptions of financial economics by incorporating these observable, systematic, and very human departures from rationality into standard models of financial markets. This paper describes empirical tests of two predictions of behavioral finance: that investors tend to sell their winning stocks and to hold on to their losers and that, as a result of overconfidence, investors trade too much.

Statman and Shefrin (1985) predict that investors will sell their winning investments too soon and hold on to their losers too long. They dub this tendency the disposition effect. Using account data from a large discount broker, we document that individual investors are 50 percent more likely to sell a winning investment than a losing investment (relative to their opportunities to do so). The analysis also indicates that many investors engage in tax-motivated selling, especially in December. Alternative explanations have been proposed for why investors might realize their profitable investments while retaining their losing investments. Investors may rationally, or irrationally, believe that their current losers will in the future outperform their current winners. They may sell winners to rebalance their portfolios. Or they may refrain from selling losers due to the higher transactions costs of trading at lower prices. When the data are controlled for rebalancing and for share price, the disposition effect is still observed. And the winning investments that investors choose to sell continue in subsequent months to outperform the losers they keep. This investment behavior is difficult to justify rationally; it is pure folly in an investor?s taxable account.

It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes. Those possessed of superior information may trade speculatively, though rational speculative traders will generally not choose to trade with each other. It is unlikely that rational trading needs account for a turnover rate of 76 percent on the New York Stock Exchange in 1998. We believe there is a simple and powerful explanation for high levels of trading on financial markets: overconfidence.

Human beings are overconfident about their abilities, their knowledge, and their future prospects. Odean (1998b) shows that overconfident investors trade more than rational investors and that doing so lowers their expected utilities. Greater overconfidence leads to greater trading and to lower expected utility.

We present evidence that the average individual investor pays an extremely large performance penalty for trading. Those investors who trade most actively earn, on average, the lowest returns. And the stocks individual investors purchase do not outperform those they sell by enough to even cover the costs of trading. In fact, the stocks individual investors purchase, on average, subsequently underperform those they sell. This is the case even when trading is not apparently motivated by liquidity demands, tax-loss selling, portfolio rebalancing, or a move to lower-risk stocks.

Our common psychological heritage insures that we systematically share decision biases that can lead to suboptimal investment behavior. Overconfidence provides the will to act on these biases. It gives us the courage of our misguided convictions.

Abstract:
Modern financial economics assumes that we behave with extreme rationality but we do not. Furthermore, our deviations from rationality are often systematic. Behavioral finance relaxes the traditional assumptions of financial economics by incorporating these observable, systematic, and very human departures from rationality into standard models of financial markets. This paper describes empirical tests of two predictions of behavioral finance: that investors tend to sell their winning stocks and to hold on to their losers and that, as a result of overconfidence, investors trade too much.

Statman and Shefrin (1985) predict that investors will sell their winning investments too soon and hold on to their losers too long. They dub this tendency the disposition effect. Using account data from a large discount broker, we document that individual investors are 50 percent more likely to sell a winning investment than a losing investment (relative to their opportunities to do so). The analysis also indicates that many investors engage in tax-motivated selling, especially in December. Alternative explanations have been proposed for why investors might realize their profitable investments while retaining their losing investments. Investors may rationally, or irrationally, believe that their current losers will in the future outperform their current winners. They may sell winners to rebalance their portfolios. Or they may refrain from selling losers due to the higher transactions costs of trading at lower prices. When the data are controlled for rebalancing and for share price, the disposition effect is still observed. And the winning investments that investors choose to sell continue in subsequent months to outperform the losers they keep. This investment behavior is difficult to justify rationally; it is pure folly in an investor?s taxable account.

It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes. Those possessed of superior information may trade speculatively, though rational speculative traders will generally not choose to trade with each other. It is unlikely that rational trading needs account for a turnover rate of 76 percent on the New York Stock Exchange in 1998. We believe there is a simple and powerful explanation for high levels of trading on financial markets: overconfidence.

Human beings are overconfident about their abilities, their knowledge, and their future prospects. Odean (1998b) shows that overconfident investors trade more than rational investors and that doing so lowers their expected utilities. Greater overconfidence leads to greater trading and to lower expected utility.

We present evidence that the average individual investor pays an extremely large performance penalty for trading. Those investors who trade most actively earn, on average, the lowest returns. And the stocks individual investors purchase do not outperform those they sell by enough to even cover the costs of trading. In fact, the stocks individual investors purchase, on average, subsequently underperform those they sell. This is the case even when trading is not apparently motivated by liquidity demands, tax-loss selling, portfolio rebalancing, or a move to lower-risk stocks.

Our common psychological heritage insures that we systematically share decision biases that can lead to suboptimal investment behavior. Overconfidence provides the will to act on these biases. It gives us the courage of our misguided convictions.

Abstract:
In this paper we document that an investment strategy based on the consensus (average) analyst recommendations of security analysts earns positive returns. For the period 1986-1996, a portfolio of stocks most highly recommended by analysts earned an annualized geometric mean return of 18.8 percent, while a portfolio of stocks least favorably recommended earned only 5.78 percent. (In comparison, an investment in a value-weighted market index earned an annualized geometric mean return of 14.5 percent.) Alternatively stated, purchasing stocks most highly recommended yielded a return of 102 basis points per month. The magnitude of this return is surprisingly large, and is far greater than the size effect (negative 16 basis points) and book-to-market effect (17 basis points) for the same period. Even after controlling for these two effects, as well as for price momentum, we show that the strategy of purchasing stocks most highly recommended and selling short those least favorably recommended yielded a return of 75 basis points per month. These results are robust to partitions by time period and overall market direction, and are most pronounced for small and medium-sized firms. The abnormal returns also persist when we allow a lapse of up to 15 days before acting on the investment recommendations. There is no extant theory of asset pricing that explains these results.

Abstract:
When an investor buys and sells the same stock on the same day, he has made a day trade. We analyze the performance of day traders in Taiwan. Day trading by individual investors is prevalent in Taiwan - accounting for over 20 percent of total volume from 1995 through 1999. Individual investors account for over 97 percent of all day trading activity. Day trading is extremely concentrated. About one percent of individual investors account for half of day trading and one fourth of total trading by individual investors. Heavy day traders earn gross profits, but their profits are not sufficient to cover transaction costs. Moreover, in the typical six month period, more than eight out of ten day traders lose money. Despite these bleak findings, there is strong evidence of persistent ability for a relatively small group of day traders. Traders with strong past performance continue to earn strong returns. The stocks they buy outperform those they sell by 62 basis points per day. This spread is sufficiently large to cover transaction costs.

day traders, individual investors, market efficiency

Abstract:
After a string of years in which security analysts' top stock picks significantly outperformed their pans, the year 2000 was a disaster. During that year the stocks least favorably recommended by analysts earned an annualized market-adjusted return of 48.66 percent while the stocks most highly recommended fell 31.20 percent, a return difference of almost 80 percentage points. This pattern prevailed during most months of 2000, regardless of whether the market was rising or falling, and was observed for both tech and non-tech stocks. While we cannot conclude that the 2000 results are necessarily driven by an increased emphasis on investment banking by analysts, our findings should add to the debate over the usefulness of analysts' stock recommendations to investors. They should also serve to alert researchers to the possibility that excluding the year 2000 from their sample period could have a significant impact on any conclusions they draw concerning analysts' stock recommendations.

Abstract:
Many public pension funds engage in institutional activism. These funds use the power of their pooled ownership of publicly traded stocks to affect changes in the corporations they own. I review the theory and empirical evidence underlying the motivation for institutional activism. In theory, the merits of institutional activism hinge critically on two agency costs: (1) the conflicts of interest between corporate managers and shareholders, and (2) the conflicts of interest between portfolio managers and investors. This leads to two types of institutional activism: shareholder activism and social activism. While portfolio managers can use their position to monitor conflicts that might arise between managers and shareholders (shareholder activism), they can also abuse their position by pursuing actions that advance their own moral values or political interests at the expense of investors (social activism). Which of these effects dominates the actions of portfolio managers will determine the value of activism and is an empirical issue. Perhaps the most high profile activism has been pursued by CalPERS with their annual focus list. I document that CalPERS has pursued reforms at focus list firms that would increase shareholder rights and (imprecisely) estimate the total wealth creation from this shareholder activism to be $3.1 billion between 1992 and 2005. Unrelated to the focus list program, CalPERS has also pursued social activism (e.g., the divestment of tobacco stocks). In general, I argue that institutional activism should be limited shareholder activism where there is strong theoretical and empirical evidence indicating the proposed reforms will increase shareholder value. At times, institutions will be forced to take engage in social activism and take positions on sensitive issues. In these situations, I argue portfolio managers should pursue the moral values or political interests of their investors rather than themselves.

shareholder activism, CalPERS, corporate governance, socially responsible investing

Abstract:
A substantial literature in institutional herding examines reasons for and evidence of correlated trading across institutional investors, but little has been written about the extent to which individual investor trading is correlated or why. We document that the trading of individuals is highly correlated and surprisingly persistent. Furthermore, we find that the systematic trading of individual investors is driven by their own decisions - trades they initiated - rather than by passive reactions to institutional herding. We discuss why this correlation is unlikely to stem from the same motivations as institutional herding. Correlated trading by individuals is a necessary condition for the trading biases of individual investors to affect asset prices, since the trades of any particular individual are likely to be small. The preferences for buying some stocks while selling others must be shared by many individual investors if these preferences are to affect prices. We analyze trading records for 66,465 households at a large national discount broker between January 1991 and November 1996 and 665,533 investors at a large retail broker between January 1997 and June 1999. Using a variety of empirical approaches, we document that the trading of individuals is more coordinated than one would expect by mere chance. For example, if individual investors are net buyers of a stock this month, they are likely to be net buyers of the stock next month.

Noise trading, herding, individual investors,

Abstract:
Theoretical models of financial markets built on the assumption that some investors are overconfident yield one central prediction: overconfident investors will trade too much. We test this prediction by partitioning investors on the basis of a variable that provides a natural proxy for overconfidence--gender. Psychological research has established that men are more prone to overconfidence than women. Thus, models of investor overconfidence predict that men will trade more and perform worse than women. Using account data for over 35,000 households from a large discount brokerage firm, we analyze the common stock investments of men and women from February 1991 through January 1997. Consistent with the predictions of the overconfidence models, we document that men trade 45 percent more than women and earn annual risk-adjusted net returns that are 1.4 percent less than those earned by women. These differences are more pronounced between single men and single women; single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are 2.3 percent less than those earned by single women.

Abstract:
From January 1996 through June 2003, the average daily abnormal return to independent research firm buy recommendations exceeds that of investment bank buy recommendations by 3.1 basis points (almost 8 percentage points annualized). Investment bank buy recommendation underperformance is more pronounced following the NASDAQ market peak (March 10, 2000) and strikingly so for buy recommendations on firms that recently conducted equity offerings. In contrast, investment bank hold and sell recommendations outperform those of independent research firms by 1.8 basis points daily (4 1/2 percentage points annualized). These results suggest reluctance by investment banks to downgrade stocks whose prospects dimmed during the bear market of the early 2000s, as claimed in the SEC's Global Research Analyst Settlement.

Analyst, recommendation, investment bank, independent research, Global Research Analyst Settlement

Abstract:
This study compares the profitability of security recommendations issued by investment banks and independent research firms. During the 1996 through mid-2003 time period, the average daily abnormal return to independent research firm buy recommendations exceeds that of the investment banks by 3.1 basis points, or almost 8 percentage points annualized. In contrast, investment bank hold and sell recommendations outperform those of independent research firms by -1.8 basis points daily, or -4½ percentage points annualized. Investment bank buy recommendation underperformance is concentrated in the subperiod subsequent to the NASDAQ market peak (March 10, 2000), where it averages 6.9 basis points per day, or slightly more than 17 percent annualized. More strikingly, during this period those investment bank buy recommendations outstanding subsequent to equity offerings underperform those of independent research firms by 8.7 basis points (almost 22 percent annualized). Taken as a whole, these results suggest that at least part of the underperformance of investment bank buy recommendations is due to a reluctance to downgrade stocks whose prospects dimmed during the early 2000's bear market, as claimed in the SEC's Global Research Analyst Settlement. Additional analyses find that the underperformance of investment bank buy recommendations extends not only to the ten investment banks sanctioned in the research settlement but to the non-sanctioned investment banks as well.

Analyst, recommendation, investment bank, broker, independent research, Global Analyst Research Settlement, accounting, stock recommendation performance, independent research firms

Abstract:
This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can be used to predict the profitability of analysts' recommendations. Consistent with prior work, we find that the percentage of buy recommendations increased substantially from 1996-2000. Starting in mid-2000, however, the percentage of buys decreased steadily. Our analysis strongly suggests that this is due, at least in part, to the implementation of NASD Rule 2711, which requires brokers' ratings distributions to be made public. Notably, over our sample period the difference between the percentage of buy recommendations of the large investment banks singled out for sanction in the Global Research Analyst Settlement and that of the non-sanctioned brokers is economically quite small.

Additionally, we find that a broker's stock ratings distribution can predict the profitability of its recommendations. Upgrades to buy issued by brokers with the smallest percentage of buy recommendations significantly outperformed those of brokers with the greatest percentage of buys, by an average of 50 basis points per month. Further, downgrades to hold or sell coming from brokers issuing the most buy recommendations significantly outperformed those of brokers issuing the fewest, by an average of 46 basis points per month.

accounting, investment banks, stock ratings, profitability

Abstract:
This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can predict the profitability of analysts' recommendations. We document that the percentage of buys decreased steadily starting in mid-2000, likely due, at least in part, to the implementation of NASD Rule 2711, requiring the public dissemination of ratings distributions. Additionally, we find that a broker's ratings distribution can predict recommendation profitability. Upgrades to buy (downgrades to hold or sell) issued by brokers with the smallest percentage of buy recommendations significantly outperformed (underperformed) those of brokers with the greatest percentage of buys.

Analyst, investment bank, broker, stock ratings, recommendations, NASD 2711

Abstract:
This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines their relation to the profitability of analysts' recommendations. Consistent with prior work, we find that the percentage of buy recommendations increased substantially from 1996-2000. Notably, though, the largest brokers, who have received the most scrutiny from regulators and the media, generally have a smaller percentage of buy recommendations than our sample as a whole. Starting in mid-2000 the percentage of buys has decreased steadily. Our analysis strongly suggests that this is due, at least in part, to the implementation of NASD Rule 2711, which requires brokers' ratings distributions to be made public. We also find that a broker's stock ratings distribution can predict the profitability of its recommendations. Upgrades to buy issued by brokers with the smallest percentage of buy recommendations significantly outperformed those of brokers with the greatest percentage of buys, by an average of 50 basis points per month. Conversely, downgrades to hold or sell coming from brokers issuing the most buy recommendations significantly outperformed those of brokers issuing the fewest, by an average of 46 basis points per month.

Analyst, investment bank, broker, stock ratings, recommendations, NASD 2711

Abstract:
Barber and Lyon (1996a) and Kothari and Warner (1996) document conventional tests of long-run abnormal returns are misspecified. In this research, we propose alternative methods to test for long-run abnormal returns. Our methods have two key characteristics. First, long-run abnormal returns are calculated using reference portfolios that yield an abnormal return measure with a population mean that is identically zero. Second, our methods control for the documented positive skewness in long-run abnormal returns calculated using reference portfolios. We control for the positive skewness by either (1) adjusting conventional t statistics using well-documented statistical methods, or (2) generating the empirical distribution of mean long-run abnormal returns via simulation. In addition to yielding reasonably well-specified test statistics in a variety of sampling situations, we document that these two methods are more powerful than the control firm approach analyzed by Barber and Lyon.

Abstract:
We document that individual investor trading results in systematic and, more importantly, economically large losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2 percent of Taiwan's GDP or 2.8 percent of total personal income - nearly as much as the total private expenditure on clothing and footwear in Taiwan. Using orders underlying trade, we document that virtually all of individual trading losses can be traced to their aggressive orders; passive orders placed by individuals are profitable at short horizons and suffer modest losses at longer horizons. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points (after commissions and taxes, but before other costs) and both the aggressive and passive trades of institutions are profitable. Foreign institutional investors garner nearly half of the institutional profits. Finally, the introduction of a legal lottery in Taiwan in 2002 coincided with a 25 percent reduction in turnover on the Taiwan Stock Exchange.

market efficiency, individual investors, institutional investors, information asymmetry

Abstract:
Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that traded most earned an annual return of 11.4 percent, while the market returned 17.9 percent. The average household earned an annual return of 16.4 percent, tilted its common stock investment toward high-beta, small, value stocks, and turned over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.

Abstract:
Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that traded most earned an annual return of 11.4 percent, while the market returned 17.9 percent. The average household earned an annual return of 16.4 percent, tilted its common stock investment toward high-beta, small, value stocks, and turned over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.

Abstract:
We argue that the purchase decisions of mutual fund investors are influenced by salient, attention-grabbing information. Investors are more sensitive to salient in-your-face fees, like front-end loads and commissions, than operating expenses; they are likely to buy funds that attract their attention through exceptional performance, marketing, or advertising. Our empirical analysis of mutual fund flows over the last 30 years yields strong support for our contention. We find consistently negative relations between fund flows and front-end load fees. We also document a negative relation between fund flows and commissions charged by brokerage firms. In contrast, we find no relation (or a perverse positive relation) between operating expenses and fund flows. Additional analyses indicate that mutual fund marketing and advertising, the costs of which are often embedded in a fund's operating expenses, account for this surprising result.

mutual funds, investor behavior, operating expenses

Abstract:
We examine changes in the stock trading behavior and investment performance of 1,607 investors who switch from phone based to online trading during the period 1992 to 1995. We document that young men who are active traders with high incomes and a preference for investing in small growth stocks with high market risk are more likely to switch to online trading. We also find that those who switch to online trading experience unusually strong performance prior to going online, beating the market by more than two percent annually. After going online, they trade more actively, more speculatively, and less profitably than before -- lagging the market by more than three percent annually. A rational response to reductions in market frictions (lower trading costs, improved execution speed, and greater ease of access) does not explain these findings. The increase in trading and reduction in performance of online investors can be explained by overconfidence augmented by self-attribution bias, the illusion of knowledge, and the illusion of control.

Abstract:
This paper tests for the existence of performance persistence in brokerage house stock recommendations. For the period 1987-1996 we show that purchasing the current-year buy recommendations of the brokerage houses with the best prior performance earned an annualized geometric mean raw return of 18.6 percent, while purchasing the recommended stocks of the houses with the worst prior performance earned only 14.3 percent. After controlling for market risk, size, book-to-market, and price momentum effects, though, we find no significant difference, in general, between the abnormal returns of the best and worst brokerage houses. A series of supplementary tests confirm this result. The findings for brokerage house sell recommendations are even weaker. Overall, our tests provide no reliable evidence of performance persistence for brokerage house stock recommendations.

Abstract:
Using account data for over 60,000 households from a large discount brokerage firm, we analyze the common stock investment performance of individual investors from February 1991 through December 1996. The average household tilts their common stock investment toward high-beta, small, value stocks, and turns over 80 per cent of their portfolio annually. On one hand, the gross returns (before accounting for transaction costs) earned by the average household are unremarkable; the average household earned an annualized geometric mean gross return of 17.7 per cent while the value-weighted market index earned 17.1 per cent. On the other hand, the net returns earned by the average household lag reasonable benchmarks by economically and statistically significant amounts; the average household earned an annualized geometric mean net return of 15.3 per cent. The 20 per cent of households that trade most (which average at least 9.6 per cent turnover per month) earned an annualized geometric mean net return of 10.0 per cent. The poor performance of those households that trade frequently is generally consistent with the implications of recent theoretical models of investor overconfidence. Our central message is that trading is hazardous to your wealth.

Abstract:
We show that abnormal returns to analysts’ recommendations stem from both the ratings levels assigned as well as the changes in those ratings. Conditional on the ratings change, buy and strong buy recommendations have greater returns than do holds, sells, and strong sells. Conditional on the ratings level, upgrades earn the highest returns and downgrades the lowest. We also find that both ratings levels and changes predict future unexpected earnings and the associated market reaction. Our results imply that (a) investment returns may be enhanced by conditioning on both recommendation levels and changes, (b) the predictive power of analysts’ recommendations reflects, at least partially, analysts’ ability to generate valuable private information, and (c) some inconsistency exists between analysts’ ratings and the formal ratings definitions issued by securities firms.

analysts, ratings, recommendations, changes, levels, returns

Abstract:
We establish two previously undocumented patterns in the purchase selections of individual investors and confirm a related pattern. These patterns hinge on investors' previous experience with a stock. We demonstrate that investors prefer to: (1) repurchase stocks they previously sold for a gain rather than stocks they previously sold for a loss, (2) repurchase stocks that have lost value subsequent to a prior sale, rather than stocks that have gained value subsequent to a prior sale, and (3) purchase additional shares of stocks that have lost value since being purchased, rather than additional shares of stocks that have gained value since being purchased. We document these trading patterns by analyzing trading records for 66,465 households at a large discount broker between January 1991 and November 1996, and 665,533 investors at a large retail broker between January 1997 and June 1999. We propose that the first trading pattern results from a simple form of learning, whereby investors repeat actions that previously resulted in pleasure while avoiding actions that previously led to pain (i.e., they repurchase their previous winners more readily than their previous losers). We argue that the second and third trading patterns are tied to counterfactuals. Investors who buy a stock at a higher price than they previously sold it are painfully aware that they are worse off than if they had simply never sold that stock. Investors who buy a stock at a lower price than they previously sold it experience the pleasure of knowing they are better off than if they had never sold that stock. Investor returns do not reliably benefit from any of the three patterns we document.

Behavioral finance, prospect theory, disposition effect, individual investors

Abstract:
The financial press makes frequent and bold claims regarding the performance of investment clubs. One oft quoted figure from a National Association of Investment Club survey states that 60 percent of investment clubs beat the market. Are these claims myth or reality?

We analyze the common stock investment performance of 166 investment clubs using account data from a large discount broker from February 1991 to January 1997. We document that the average club earned an annualized geometric mean return of 14.1 percent, while a market index returned 17.9 percent. In addition, 60 percent of the clubs we analyze underperform the index. Not only did the average club fail to beat the market, it failed to match the performance of the average individual investor, who earned 16.4 percent during our sample period.

There are two reasons for the poor performance of investment clubs relative to individuals during our sample period -- trading costs and investment style. Despite having roughly similar account sizes, clubs execute smaller trades and hold more stocks than do individuals. Thus their proportionate cost of trading is higher. These higher proportionate trading costs account for approximately one-third of the clubs' performance shortfall relative to individuals. The remaining two-thirds of the shortfall are accounted for by investment style. Relative to individuals, clubs tilt more toward large stocks and growth stocks. During our sample period, large stocks underperformed small stocks (by 15 basis points per month) and growth stocks underperformed value stocks (by 20 basis points per month).

Investment clubs serve many useful functions: They encourage savings. They educate their members about financial matters. They foster friendships and social ties. They entertain. Unfortunately, their investments do not beat the market.

Abstract:
The financial press makes frequent and bold claims regarding the performance of investment clubs. One oft quoted figure from a National Association of Investment Club survey states that 60 percent of investment clubs beat the market. Are these claims myth or reality?

We analyze the common stock investment performance of 166 investment clubs using account data from a large discount broker from February 1991 to January 1997. We document that the average club earned an annualized geometric mean return of 14.1 percent, while a market index returned 17.9 percent. In addition, 60 percent of the clubs we analyze underperform the index. Not only did the average club fail to beat the market, it failed to match the performance of the average individual investor, who earned 16.4 percent during our sample period.

There are two reasons for the poor performance of investment clubs relative to individuals during our sample period -- trading costs and investment style. Despite having roughly similar account sizes, clubs execute smaller trades and hold more stocks than do individuals. Thus their proportionate cost of trading is higher. These higher proportionate trading costs account for approximately one-third of the clubs? performance shortfall relative to individuals. The remaining two-thirds of the shortfall are accounted for by investment style. Relative to individuals, clubs tilt more toward large stocks and growth stocks. During our sample period, large stocks underperformed small stocks (by 15 basis points per month) and growth stocks underperformed value stocks (by 20 basis points per month).

Investment clubs serve many useful functions: They encourage savings. They educate their members about financial matters. They foster friendships and social ties. They entertain. Unfortunately, their investments do not beat the market.

Abstract:
We ask whether the typical investor and the aggregate investor exhibit a bias known as the disposition effect, the tendency to sell investments are held for a profit at a faster rate than investments held for a loss. We analyze all trading activity on the Taiwan Stock Exchange (TSE) for the five years ending in 1999. Using a dataset that contains all trades (over one billion) and the identity of every trader (nearly four million), we find that in aggregate, investors in Taiwan are about twice as likely to sell a stock if they are holding that stock for a gain rather than as loss. Eighty-four percent of all Taiwanese investors sell winners at a faster rate than losers. Individuals, corporations, and dealers are reluctant to realize losses, while mutual funds and foreigners, who together account for less than five percent of all trades (by value), are not.

Disposition effect, behavioral finance, investor behavior

Abstract:
We ask whether the typical investor and the aggregate investor exhibit a bias known as the disposition effect, the tendency to sell investments that are held for a profit at a faster rate than investments held for a loss. We analyse all trading activity on the Taiwan Stock Exchange (TSE) for the five years ending in 1999. Using a dataset that contains all trades (over one billion) and the identity of every trader (nearly four million), we find that in aggregate, investors in Taiwan are about twice as likely to sell a stock if they are holding that stock for a gain rather than a loss. Eighty-four percent of all Taiwanese investors sell winners at a faster rate than losers. Individuals, corporations, and dealers are reluctant to realise losses, while mutual funds and foreigners, who together account for less than 5% of all trades (by value), are not.

Abstract:
We analyze the representation of women on the faculties of US business schools over the period 2002 to 2009. While women are a distinct minority on the faculties of US business schools, their ranks are increasing. At the end of our sample period, 25.3% of faculty members are women, up from 20.0% in 2002. The percentage of women is higher among untenured than among tenured faculty. The representation of women and its variation across schools are not random. Small schools and schools in the northeast have better representation of women on their faculty. Perhaps most strikingly, schools ranked among the top 50 by US News have fewer women on their faculty. We discuss possible reasons for the latter result, but the empirical observation that ranked schools have fewer women remains an intriguing puzzle.

gender, faculty, business schools

Abstract:
Individual investor trading results in systematic and economically large losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individuals suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2% of Taiwan's gross domestic product or 2.8% of the total personal income. Virtually all individual trading losses can be traced to their aggressive orders. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points, and both the aggressive and passive trades of institutions are profitable. Foreign institutions garner nearly half of institutional profits.

G11, G14, G15, H31

Abstract:
We study the trading of individual investors using transaction data and identifying buyer- or seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon, small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns.

G11, G12, G14

Abstract:
We test and confirm the hypothesis that individual investors are net buyers of attention-grabbing stocks, e.g., stocks in the news, stocks experiencing high abnormal trading volume, and stocks with extreme one-day returns. Attention-driven buying results from the difficulty that investors have searching the thousands of stocks they can potentially buy. Individual investors do not face the same search problem when selling because they tend to sell only stocks they already own. We hypothesize that many investors consider purchasing only stocks that have first caught their attention. Thus, preferences determine choices after attention has determined the choice set.

Abstract:
In this paper we compare the investment decisions of groups (stock clubs) and individuals. Both individuals and clubs are more likely to purchase stocks that are associated with good reasons (e.g., a company that is featured on a list of most admired companies). However, stock clubs favor such stocks more than individuals despite the fact that such reasons do not improve performance. We describe why social dynamics may make good reasons more important for groups than individuals.

Reason-based choice, group decision making, group polarization

Abstract:
Using brokerage account data, we analyze the tax awareness of individual investors. We find strong evidence that taxes matter: investors prefer to locate bonds and mutual funds in retirement accounts and, in December, harvest stock losses in their taxable accounts. However, investors also trade actively in their taxable accounts, realize gains more frequently than losses, and locate a material portion of their bonds in taxable accounts. Though taxes leave clear footprints in the data we analyze, many investors could improve their after-tax performance by fully capitalizing on the tax avoidance strategies available to equities, while optimally locating their assets.

Aasset location, asset allocation, portfolio choice, taxation

Abstract:
After a string of years in which security analysts' top stock picks significantly outperformed their pans, the years 2000 and 2001 were disasters. During those two years, the stocks least favored by analysts earned an average annualized market-adjusted return of 13.44 percent whereas the stocks most highly recommended underperformed the market by 7.06 percent, a return difference of more than 20 percentage points. This pattern prevailed during most months of 2000 and 2001 and was observed for both technology and non-technology stocks. Additional analysis suggests that these poor results were driven, at least in part, by analysts' tendency to recommend small-capitalization growth stocks during those years, despite the fall of those stocks from favor. Whether or not this preference was motivated by a desire to attract and retain the most lucrative investment banking clients, our findings should add to the debate over the usefulness of analyst stock recommendations. They should also serve to alert researchers to the possibility that excluding 2000 and 2001 from their sample periods could have a significant impact on any conclusions they draw about analyst stock recommendations.

Equity Investments: fundamental analysis and valuation models

Abstract:
Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men's net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women.

Abstract:
Using the ratio of odd-lot purchases to sales as a measure of small investor sentiment, this research documents that small firms do well (poorly) when small investors are optimistic (pessimistic). In contrast, large firms are generally unaffected by the sentiment of small investors. From 1941 through 1989, 6.5% of the time-series variation in the small firm premium can be explained by this measure of investor sentiment. Furthermore, the ratio of odd-lot purchases to sales serves as a complement to, rather than substitute for, other measures of investor sentiment including the discounts of closed-end funds and the ratio of mutual fund sales to redemptions.

Abstract:
Many recent studies have analyzed the impact that corporate events or managerial decisions have on operating performance. In these studies, researchers face many methodological choices. This paper analyzes the effect that three dimensions of choice have on the specification and power of test-statistics designed to detect abnormal operating performance: (1) the selection of a performance measures (e.g. return on assets or return on sales), (2) the selection of a statistical test (e.g., parametric t-statistic or non-parametric Wilcoxon T*), and (3) the selection of a performance benchmark (where we evaluate nine different performance benchmarks). On the first two dimensions (choice of performance measures and statistical test) we generally find little difference in the specification and power of test-statistics. However, on the third dimension (choice of performance benchmark), only one benchmark -- matching sample firms to firms with the same two-digit SIC code and similar past performance -- is well-specified. In the conclusion, we provide specific recommendations about the choice of performance measure, test-statistic, and benchmark.

Abstract:
Fama and French (1992) document a significant relation between firm size, book-to-market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book-to-market ratios, and security returns are similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book-to-market premiums in returns. Our results indicate data-snooping and selection biases do not explain the size and book-to-market patterns in returns.

Abstract:
This research analyzes the recall experience of threeAmerican (Chrysler, Ford, and GM) and three Japanese (Honda, Nissan, and Toyota) automakers during the period 1973-1992 to provide more conclusive evidence that the stock market imposes a reputation penalty on automakers that produce unreliable vehicles. We view recall campaigns as a manifestation of underlying product reliability, which is an important aspect of product quality. First, we document that the incidence of recalls for American automakers has been significantly higher than their Japanese counterparts. Furthermore, the Japanese advantage has persisted during the second decade of our sample (1983-1992). Second, we document a link between recalls and firm value by analyzing the stock market reaction to the announcement of recall campaigns. On average when an automaker announces a recall campaign, (1) the announcement has a statistically and economically significant impact on the shareholder value of the announcing firm, (2) the announcement does not significantly impact the shareholder value of competitor firms, (3) the market response to each recall is marginally larger for Japanese automakers, but (4) the total cumulative losses are larger for the US automakers. These findings suggest that the stock market functions as a disciplinary mechanism and that, ceteris paribus, automakers can improve the welfare of their shareholders by improving product reliability.

Abstract:
We analyze the empirical power and specification of test- statistics in event studies designed to detect long-run (one to five-year) abnormal stock returns. We consider (1) the calculation of long-run abnormal returns by comparing summed monthly abnormal returns (cumulative abnormal returns) to holding period abnormal returns (buy-and-hold abnormal returns), (2) the construction of an appropriate return benchmark by considering the use of reference portfolios, control firms, and an application of the Fama-French three-factor model, and (3) the impact of sampling biases. When long-run abnormal returns are calculated as the buy-and-hold return of a sample firm less the buy-and-hold return of a reference portfolio (such as a market index), we document that test-statistics are significantly negatively biased. However, this negative bias is alleviated when buy-and-hold abnormal returns are calculated as returns of sample firms less returns of an appropriately selected control firm.

Abstract:
We document that long-run market-adjusted cumulative abnormal returns generally yield positively biased test statistics, while long-run market-adjusted buy-and-hold abnormal returns generally yield negatively biased test statistics. However, these general results are sensitive to (1) the period analyzed, (2) the inclusion of NASDAQ firms, and (3) the requirement of pre-event data. These three factors explain the why Barber and Lyon (1996) and Kothari and Warner (1996) obtain apparently contradictory results in their analysis of long-run abnormal returns.

Abstract:
Barber and Lyon (1997a) and Kothari and Warner (1997) document that standard tests of long-run abnormal returns are misspecified. In this research, we evaluate alternative methods to test for long-run abnormal returns. We document that two general approaches yield well-specified test statistics in random samples. The first approach uses a traditional event study framework and buy-and-hold abnormal returns calculated using carefully constructed reference portfolios, such that the population mean abnormal return is identically zero. Inference is based on either a skewness-adjusted t statistic or the empirically generated distribution of mean long-run abnormal returns. The second approach is based on the calculation of mean monthly abnormal returns using calendar-time portfolios and a time-series t statistic. Though both approaches perform well in random samples, misspecification in nonrandom samples is pervasive. Our central message is that the analysis of long-run abnormal returns is treacherous.

Abstract:
A vexing problem for the appraisal industry has been estimating an appropriate discount for the value of real estate limited partnerships (RELPs) relative to their appraised value. This research develops a linear regression model that explains over 80% of the cross-sectional variation in discounts across 60 RELPs using characteristics of each partnership. Among a holdout sample of 41 RELPs, the model provides forecasts of discounts that are superior to assuming no discount or applying a mean discount to all partnerships. Discounts are greatest for RELPs with low current yields, low leverage and high trading ranges for their market prices.