Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders

20 Pages Posted: 7 Sep 2016

See all articles by Francis Larson

Francis Larson

Normann

John A. List

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Robert Metcalfe

University of Chicago - Becker Friedman Institute for Economics

Date Written: September 2016

Abstract

Behavioral economists have recently put forth a theoretical explanation for the equity premium puzzle based on combining myopia and loss aversion. Complementing the behavioral theory is evidence from laboratory experiments, which provide strong empirical support consistent with myopic loss aversion (MLA). Yet, whether, and to what extent, such preferences underlie behaviors of traders in their natural domain remains unknown. Indeed, a necessary condition for the MLA theory to explain the equity premium puzzle is for marginal traders in markets to exhibit such preferences. Using minute-by-minute trading observations from over 864,000 price realizations in a natural field experiment, we find data patterns consonant with MLA: in their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information. Beyond testing theory, these results have important implications for efficient resource allocation as well as characterizing the optimal structure of social and economic policies.

Suggested Citation

Larson, Francis and List, John A. and Metcalfe, Robert, Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders (September 2016). NBER Working Paper No. w22605, Available at SSRN: https://ssrn.com/abstract=2835862

Francis Larson (Contact Author)

Normann ( email )

London
United Kingdom

HOME PAGE: http://normann.io

John A. List

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Robert Metcalfe

University of Chicago - Becker Friedman Institute for Economics ( email )

Chicago, IL 60637
United States

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