Asymmetric Motivated Reasoning in Investor Judgment

Abstract

We develop and test a refinement to motivated reasoning theory that predicts long investors are more prone than short investors to forming biased beliefs about the value of a stock. Our theory suggests that motivated reasoning is muted for short investors because the investing setting conveys a conventional preference for prices to go up that is directionally inconsistent with short investors’ incentivized preference for prices to go down. We examine this overarching premise across four experiments. Experiment 1 tests our theory in an investing setting in which participants take either long or short positions. Compared to a rational benchmark for an unbiased judgment, we find that long traders’ estimates of future stock price exhibit upward bias while short traders’ estimates are unbiased. Consistent with motivated reasoning as the process underlying these results, the magnitude of long traders’ bias becomes less pronounced as the amount of uncertainty in the information environment decreases. Experiment 2 suggests that direct experience with taking short positions can increase short traders’ propensity to engage in motivated reasoning. Experiments 3 and 4 provide additional evidence for our theory outside of the investing context. Overall, our paper contributes new insights into differences between long and short investors and speaks to the broader literature on bias in judgment and decision-making that spans multiple fields.

Keywords: motivated reasoning, incentives, investors, short selling, uncertainty