The 'Ostrich Effect' and the Relationship between the Liquidity and the Yields of Financial Assets
Posted: 2 Jun 2005
This paper documents that government T-bills provided a higher Yield to Maturity than an equally risky illiquid asset (bank deposits) in Israel. This cannot be attributed to taxes, risk or transaction costs. We relate our finding to the Myopic Loss Aversion literature (MLA) and suggest that the observed puzzle is due to the positive correlation between liquidity and the flow of market information. We use the term "Ostrich Effect", to describe investor behavior, since ostriches are believed to treat apparently risky situations by pretending they do not exist. As predicted by the Ostrich Effect, we find that the difference between the return on the liquid asset relative to the illiquid asset is higher in periods of greater uncertainty.
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