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Ch08.pdf
1.
Chapter 8: The
Impact of Heuristics and Biases on Financial Decision-making Powerpoint Slides to accompany Behavioral Finance: Psychology, Decision-making and Markets by Lucy F. Ackert & Richard Deaves ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. 1
2.
Home bias • Domestic
investors hold mostly domestic securities. – American investors hold mostly U.S. securities – Japanese investors hold mostly Japanese securities. – British investors hold mostly U.K. securities. • In so doing they forego gains from international diversification. 2 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
3.
Investor international holdings 3 ©2010
Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. Source: French, K. R., and J. M. Poterba, 1991, "Investor diversification and international equity markets," American Economic Review 81, 222-26.
4.
Potential home bias
explanations • Excessive optimism about prospects of domestic market. • Comfort-seeking and familiarity. – What is familiar is good (i.e., a good investment) • Institutional restrictions: – Capital movement restrictions – Differential trading costs – Differential tax rates • Latter likely plays a very minor role. 4 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
5.
Excessive domestic optimism
would imply a lot of disagreement among investor groups 5 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. Source: French, K. R., and J. M. Poterba, 1991, "Investor diversification and international equity markets," American Economic Review 81, 222-26.
6.
Home bias within
a country • Home bias seems to be driven by a comfort- level with the familiar. • In 1984, AT&T was forced by the court into a divestiture whereby seven “Baby Bells” were created. • Created along regional lines – example: Bellsouth serving southeastern United States. 6 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
7.
Familiarity and home
bias • If people like familiarity, then we would expect that a disproportionate number of a Baby Bell’s customers to hold a disproportionate number of shares in the same Baby Bell. • Exactly what happened after the divestiture. 7 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
8.
Poor diversification is
implied • From diversification standpoint, if anything you are wise to underweight (not overweight) local companies. • If you work and invest locally, technically speaking, your two income sources are highly correlated. • Diversification theory says you should look for income streams that are weakly correlated. • Better for investors to buy stock in Baby Bells outside their region. 8 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
9.
Language • In Finland,
there are two official languages, Finnish and Swedish. • Annual reports are normally published in Finnish or in both official languages, but in a few cases reports are only published in Swedish. • Controlling for other relevant factors, Finnish investors prefer companies whose language of publication is Finnish. • And Swedish investors prefer companies whose language is Swedish – with bilingual companies being mid-ranked. 9 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
10.
Culture • From the
same study, culture matters as well. • It was noted whether CEOs were Finnish or Swedish. • Controlling for language of the company, Finnish speakers prefer Finnish CEOs. • And Swedish speakers prefer Swedish CEOs. 10 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
11.
Home bias and
informational advantage • A rational explanation for local preference is informational advantage. – You know more about what is close. – Gains from being local to a company may appear in improved monitoring capability and access to private information. 11 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
12.
Evidence from mutual
fund manager behavior • Consistent with familiarity bias, managers tend to favor local firms. • Average manager invests in companies that are 160-84 kilometers, or 9-11%, closer to her than the average firm she could have held. • Local preference is related to firm size: tendency to invest locally stronger for smaller firms (where informational advantage is likely to be greater). 12 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
13.
Does local preference
boost performance? • Significant payoff to local preference. • Fund managers on average earn 2.67%/year more on local investments. • While local stocks avoided by managers underperform by 3%/year. • And those better able to select local stocks tend to concentrate their holdings more locally. 13 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
14.
Can retail investors
profit from local information? • Evidence that retail investors also have some ability in this regard. • Reminiscent of money manager finding, based on a dataset of retail investors, local investments outperformed remote investments by 3.2%/year. 14 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
15.
Representativeness: “Good companies are
good investments” Seems obvious that if a company has high- quality management, a strong image and has enjoyed consistent growth in earnings, it must be a good investment. Students of finance of course know better. Positive qualities should already be embedded in price Loosely speaking, good companies will already sell at high prices, and bad companies will already sell at low prices 15 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
16.
But do executives
know better? Fortune magazine has been surveying senior executives on company attributes for a number of years. Executives are asked to assign values between ‘0’ (poor) and ‘10’ (excellent) to each company in their industry for the following items: quality of management quality of products/services innovativeness long-term investment value financial soundness ability to attract, develop, and keep talented people responsibility to the community and environment wise use of corporate assets 82% of respondents consider quality of management as most important attribute of a company’s quality. 16 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
17.
Regressions involving management
quality 17 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
18.
Interpretation See first
row (upper panel). Management quality (i.e., good company) and value as a long-term investment (i.e., good stock) are very highly correlated. Note high R-squared. Executives believe that good companies are good stocks. But no company attribute should be associated with investment value. 18 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
19.
Interpretation cont. See
third row of lower panel. Two firm characteristics, size and book (value) to market (price), are strongly associated with perceived management quality. Big companies and those that have low book-to-market ratios (growth companies) are viewed as good companies Not surprising: Big companies have often become big because they are good (i.e., well-managed) And growth can only come from quality 19 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
20.
Interpretation cont. ii.
See last regression in upper panel. Value as a long-term investment is regressed on size, book- to-market and management quality. As before, latter strongly impacts perceived investment value. Additionally, size and book-to-market, even accounting for their impact on management quality, independently influence perceived investment value. In other words, big high-growth firms are representative of good investments But opposite is true! Is this behind fact big high-growth firms are inferior investments? 20 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
21.
Momentum-chasing: Survey evidence •
Survey of workers managing their own retirement money. • Respondents were to asked to start their pensions from scratch and allocate money between two stocks: – One with an “average return over the last 5 years of 5%” – And a second with an “average return over the last 5 years of 15%.” – Further told that “analysts forecast that both stocks should earn about 10% per year over the next 5 years.” 21 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
22.
Loser vs. winner
percentage difference 22 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. Source: Deaves, R., 2005, "Flawed self-directed retirement account decision-making and its implications," Canadian Investment Review (Spring), 6-15.
23.
Interpretation • Mode is
at zero – which is a good answer. • Most are momentum-chasers (64%). • A very high spike indicates many chase momentum to the point of losing all diversification. • There are some contrarians (12%) but many go too far and lose diversification. • Mean loser vs. winner percentage: -33%. • Conclusion: many people forego scope for diversification by leaning toward the momentum- chasing stock. 23 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
24.
Digression: Momentum-chasing and company
stock • In studying plan member new allocations into company stock, one researcher has established that much of it was from chasing winners. • Forming portfolios based on 1-yr/10-yr own- company stock returns: – Low-return portfolios had 21%/10% put into company stock – High-return portfolios had 24%/40% put into company stock 24 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
25.
Does chasing past
returns make sense? • Academic evidence is somewhat subtle here: • There is evidence of (a little) intermediate-term momentum (3-month to 1-year returns) • But there is also evidence of reversals for longer-term returns (3-5-year returns) • So best answer to survey question is to be a slight contrarian – but one has to be careful not to surrender diversification • Absolutely fine to go 50/50 and maximize diversification. 25 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
26.
Anchoring: Real estate appraisal
study • Two randomly selected groups of real estate agents were taken to a house and asked to appraise it. • Same information set, including house’s (purported) list price. • Only difference between the two groups was that the first group was given a list price of $65,900, while the second group was given a list price of $83,900 -- $18,000 more. 26 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
27.
List prices and
appraisals 27 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part. Source: Northcraft, G. B., and M. A. Neale, 1987, "Experts, amateurs and real estate: An anchoring-and-adjustment perspective on property pricing decisions,“ Organizational Behavior and Human Decision Processes 39, 84-97.
28.
Anchoring: Real estate appraisal
study cont. • Average appraisal price of the first group came in at $67,811 – second group was at $75,190. • If we take the mid-point of these values ($71,500.50) as our best estimate of the true appraisal value, the gaps between the two appraisal averages was a full 10%. • Agents were anchored on list prices that they were exposed to – despite the fact that only 25% mentioned list price as one of the factors that they considered. 28 ©2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly available website, in whole or in part.
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