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Predictable Behavior, Profits, and Attention

Mark S. Seasholes

Hong Kong University of Science & Technology (HKUST)

Guojun Wu

University of Houston; China Academy of Financial Research (CAFR)

January 5, 2005

AFA 2006 Boston Meetings Paper

This paper studies the set of links between a behavioral bias, transitory price movements, and the rational response to the bias. We show that attention-grabbing events lead active individual investors to consider and ultimately buy stocks they have not previously owned. Not all attention-grabbing events lead to predictable behavior. Only those events that lower search costs (i.e., events that narrow the set of stocks under consideration) lead to attention-based buying. We show that attention-based buying is linked to transitory price shocks with a magnitude of 1.29% and duration of 10 days. We also hypothesize and show that behavioral biases do not exist in a vacuum - especially biases that are linked to asset price movements. Rational arbitrageurs (smart traders) profit in response to attention-based buying. The smart traders earn one day profits of 0.76% net of transaction costs. We are able to decompose the smart traders' profits into a portion related to liquidity provision (58%) and a portion related to taking advantage of attention-based buying (42%). Our data and profit decomposition allow us to calculate the substantial economic cost of a behavioral bias borne by individual investors.

Number of Pages in PDF File: 41

Keywords: Attention, statistical arbitrage, behavioral finance

JEL Classification: G14, G15

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Date posted: March 22, 2005  

Suggested Citation

Seasholes, Mark S. and Wu, Guojun, Predictable Behavior, Profits, and Attention (January 5, 2005). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=686193 or http://dx.doi.org/10.2139/ssrn.686193

Contact Information

Mark S. Seasholes (Contact Author)
Hong Kong University of Science & Technology (HKUST) ( email )
Clear Water Bay, Kowloon
Hong Kong
+852 2358-7668 (Phone)
HOME PAGE: http://www.seasholes.com
Guojun Wu
University of Houston ( email )
220F Melcher Hall
Houston, TX 77204-6021
United States
713-743-4813 (Phone)
713-743-4789 (Fax)
HOME PAGE: http://www.bauer.uh.edu/wu
China Academy of Financial Research (CAFR)
1954 Huashan Road
Shanghai P.R.China, 200030

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