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Are Small Investors Naive About Incentives?

51 Pages Posted: 27 Mar 2007  

Ulrike Malmendier

University of California, Berkeley - Department of Economics; University of California, Berkeley - Haas School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)

Devin M. Shanthikumar

University of California, Irvine - Paul Merage School of Business

Abstract

Security analysts tend to bias stock recommendations upward, particularly if they are affiliated with the underwriter. We analyze how investors account for such distortions. Using the NYSE Trades and Quotations database, we find that large traders adjust their trading response downward: they exert buy pressure following strong buy recommendations, no reaction to buy recommendations, and selling pressure following hold recommendations. This discounting is even more pronounced when the analyst has an underwriter affiliation. Small traders, instead, follow recommendations literally. They exert positive pressure following both buy and strong buy recommendations and zero pressure following hold recommendations. We discuss possible explanations for the differences in trading response, including information costs and investor naiveté.

Keywords: Stock recommendations, Trade reaction, Individual and institutional investors, Conflicts of interest, Behavioral finance

JEL Classification: G14, G25, G29, D82, D83

Suggested Citation

Malmendier, Ulrike and Shanthikumar, Devin M., Are Small Investors Naive About Incentives?. Journal of Financial Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=975028

Ulrike Malmendier

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
(510) 642-8724 (Phone)
(510) 642-6615 (Fax)

HOME PAGE: http://www.econ.berkeley.edu/~ulrike/

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Institute for the Study of Labor (IZA)

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

HOME PAGE: http://www.iza.org/en/webcontent/personnel/photos/index_html?key=918

Devin M. Shanthikumar (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
SB 440
Irvine, CA 92697-3125
United States

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