Subjective Learning of Trading Talent: Theory and Evidence from Individual Investors in the U.S.
Posted: 25 Nov 2020 Last revised: 4 Sep 2021
Date Written: November 30, 2020
Recent studies show evidence that investors learn about their trading abilities. This paper focuses on understanding how investors learn about their talent and proposes a unifying framework that explains many puzzling facts about individual equity investors. In my model, the investor forms subjective beliefs both about the expected return of the current stock-in-holding and about her trading talent represented by the expected return of the next replacement stock, and updates beliefs through learning with fading memory. I calibrate the memory decay parameters to individual trading records, and show that talent learning is about 7 times more sensitive to return signals than stock-in-holding learning. Consequently, the model indicates that stock switching always happens following good performance of the current stock because switching requires a sufficiently large wedge between expected returns of the replacement stock and the current stock to cover the fixed cost, which strongly predicts disposition effect in a learning perspective. This framework also accounts for the performance-contingent trading intensity and attrition, and explains why a negative shock would lead to attrition when an investor has several years of experience, which is inconsistent with the decreasing-gain updating under standard Bayesian learning.
Keywords: Subjective Learning, Trading Talent, Overoptimism, Disposition Effect, Attrition
JEL Classification: D83, G40, G41, G11, D91
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