Hostname: page-component-78c5997874-xbtfd Total loading time: 0 Render date: 2024-11-03T08:49:21.538Z Has data issue: false hasContentIssue false
  • English
  • Français

Hard-to-Value Stocks, Behavioral Biases, and Informed Trading

Published online by Cambridge University Press:  08 October 2009

Alok Kumar
Alok Kumar*
Affiliation:
McCombs School of Business, University of Texas at Austin, 1 University Station, B6600, Austin, TX 78712. [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper uses investor-level data to provide direct evidence for an intuitive but surprisingly untested proposition that investors make larger investment mistakes when valuation uncertainty is higher and stocks are more difficult to value. Using multiple measures of valuation uncertainty and multiple behavioral bias proxies, I show that individual investors exhibit stronger behavioral biases when stocks are harder to value and when market-level uncertainty is higher. I also find that informed trading intensity is higher among stocks where individual investors exhibit stronger behavioral biases. Collectively, these results indicate that uncertainty at both stock and market levels amplifies individual investors’ behavioral biases and that relatively better informed investors attempt to exploit those biases.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 6 , December 2009 , pp. 1375 - 1401
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Andreassen, P. B. “Explaining the Price-Volume Relationships: The Difference between Price Changes and Changing Prices.” Organizational Behavior and Human Decision Processes, 41 (1988), 371–389.CrossRefGoogle Scholar
Bailey, W. B.; Kumar, A.; and Ng, D. T.. “Foreign Investments of U.S. Individual Investors: Causes and Consequences.” Management Science, 54 (2008), 443–459.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” Journal of Finance, 55 (2000), 773–806.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” Quarterly Journal of Economics, 116 (2001), 261–292.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “All That Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors.” Review of Financial Studies, 21 (2008), 785–818.CrossRefGoogle Scholar
Barber, B. M.; Odean, T.; and Zhu, N.. “Systematic Noise.” Journal of Financial Markets, 12 (2009), 547–569.CrossRefGoogle Scholar
Barberis, N., and Huang, M.. “Preferences with Frames: A New Utility Specification That Allows for the Framing of Risks.” Journal of Economic Dynamics and Control, 33 (2009), 1555–1576.CrossRefGoogle Scholar
Barberis, N.; Shleifer, A.; and Vishny, R.. “A Model of Investor Sentiment.” Journal of Financial Economics, 49 (1998), 307–343.CrossRefGoogle Scholar
Bohn, H., and Tesar, L. L.. “U.S. Equity Investment in Foreign Markets: Portfolio Rebalancing or Return Chasing?” American Economic Review, 86 (1996), 77–81.Google Scholar
Chen, N.-F.; Roll, R.; and Ross, S. A.. “Economic Forces and the Stock Market.” Journal of Business, 59 (1986), 383–403.CrossRefGoogle Scholar
Daniel, K.; Hirshleifer, D.; and Subrahmanyam, A.. “Investor Psychology and Security Market Under and Overreactions.” Journal of Finance, 53 (1998), 1839–1885.CrossRefGoogle Scholar
Daniel, K. D.; Hirshleifer, D.; and Subrahmanyam, A.. “Overconfidence, Arbitrage, and Equilibrium Asset Pricing.” Journal of Finance, 56 (2001), 921–965.CrossRefGoogle Scholar
DeLong, J. B.; Shleifer, A.; Summers, L. H.; and Waldmann, R. J.. “Noise Trader Risk in Financial Markets.” Journal of Political Economy, 98 (1990), 703–738.CrossRefGoogle Scholar
Driscoll, J. C., and Kraay, A. C.. “Consistent Covariance Matrix Estimation with Spatially Dependent Panel Data.” Review of Economics and Statistics, 80 (1998), 549–560.CrossRefGoogle Scholar
Easley, D.; Hvidkjaer, S.; and O’Hara, M.. “Is Information Risk a Determinant of Asset Returns?” Journal of Finance, 57 (2002), 2185–2221.CrossRefGoogle Scholar
Easley, D.; Hvidkjaer, S.; and O’Hara, M.. “Factoring Information into Returns.” Journal of Financial and Quantitative Analysis, forthcoming (2009).Google Scholar
Einhorn, H. J. “Overconfidence in Judgement.” New Directions for Methodology of Social and Behavioral Science, 4 (1980), 1–16.Google Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607–636.CrossRefGoogle Scholar
Ferson, W. E., and Schadt, R. W.. “Measuring Fund Strategy and Performance in Changing Economic Conditions.” Journal of Finance, 51 (1996), 425–461.CrossRefGoogle Scholar
French, K. R., and Poterba, J. M.. “Investor Diversification and International Equity Markets.” American Economic Review, 81 (1991), 222–226.Google Scholar
Gompers, P. A., and Metrick, A.. “Institutional Investors and Equity Prices.” Quarterly Journal of Economics, 116 (2001), 229–259.CrossRefGoogle Scholar
Griffin, D., and Tversky, A.. “The Weighing of Evidence and the Determinants of Confidence.” Cognitive Psychology, 24 (1992), 411–435.CrossRefGoogle Scholar
Grinblatt, M., and Keloharju, M.. “How Distance, Language, and Culture Influence Stockholdings and Trades.” Journal of Finance, 56 (2001), 1053–1073.CrossRefGoogle Scholar
Hirshleifer, D. A. “Investor Psychology and Asset Pricing.” Journal of Finance, 56 (2001), 1533–1597.Google Scholar
Huberman, G. “Familiarity Breeds Investment.” Review of Financial Studies, 14 (2001), 659–680.CrossRefGoogle Scholar
Ivković, Z., and Weisbenner, S.. “Local Does as Local Is: Information Content of the Geography of Individual Investors’ Common Stock Investments.” Journal of Finance, 60 (2005), 267–306.CrossRefGoogle Scholar
Jiang, G.; Lee, C. M.; and Zhang, Y.. “Information Uncertainty and Expected Returns.” Review of Accounting Studies, 10 (2005), 185–221.CrossRefGoogle Scholar
Kahneman, D. “Maps of Bounded Rationality: Psychology for Behavioral Economics.” American Economic Review, 93 (2003), 1449–1475.CrossRefGoogle Scholar
Kahneman, D., and Lovallo, D.. “Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking.” Management Science, 39 (1993), 17–31.CrossRefGoogle Scholar
Kahneman, D., and Tversky, A.. “On the Psychology of Prediction.” Psychological Review, 80 (1973), 237–251.CrossRefGoogle Scholar
Kahneman, D., and Tversky, A.. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica, 47 (1979), 263–291.CrossRefGoogle Scholar
Kumar, A., and Lee, C. M.. “Retail Investor Sentiment and Return Comovements.” Journal of Finance, 61 (2006), 2451–2486.CrossRefGoogle Scholar
Kumar, A., and Lim, S. S.. “How Do Decision Frames Influence the Stock Investment Choices of Individual Investors?” Management Science, 54 (2008), 1052–1064.CrossRefGoogle Scholar
Lichtenstein, S., and Fischhoff, B.. “Do Those Who Know More Also Know More about How Much They Know? The Calibration of Probability Judgments.” Organizational Behavior and Human Performance, 20 (1977), 159–183.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Odean, T. “Are Investors Reluctant to Realize Their Losses?” Journal of Finance, 53 (1998), 1775–1798.CrossRefGoogle Scholar
Odean, T. “Do Investors Trade Too Much?” American Economic Review, 89 (1999), 1279–1298.CrossRefGoogle Scholar
Pástor, L., and Veronesi, P.. “Stock Valuation and Learning about Profitability.” Journal of Finance, 58 (2003), 1749–1789.CrossRefGoogle Scholar
Petersen, M. A. “Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches.” Review of Financial Studies, 22 (2009), 435–480.CrossRefGoogle Scholar
Read, D., and Loewenstein, G.. “Diversification Bias: Explaining the Discrepancy in Variety Seeking between Combined and Separated Choices.” Journal of Experimental Psychology: Applied, 1 (1995), 34–49.Google Scholar
Shefrin, H. M., and Statman, M.. “The Disposition to Sell Winners Too Early and Ride Losers Too Long.” Journal of Finance, 40 (1985), 777–790.CrossRefGoogle Scholar
Thaler, R. H. “Toward a Positive Theory of Consumer Choice.” Journal of Economic Behavior and Organization, 1 (1980), 39–60.CrossRefGoogle Scholar
Tversky, A., and Kahneman, D.. “The Framing of Decisions and the Psychology of Choice.” Science, 211 (1981), 453–458.CrossRefGoogle ScholarPubMed
Tversky, A., and Kahneman, D.. “Rational Choice and the Framing of Decisions.” Journal of Business, 59 (1986), S251–S278.CrossRefGoogle Scholar
Zhang, X. F. “Information Uncertainty and Stock Returns.” Journal of Finance, 61 (2006), 105–136.CrossRefGoogle Scholar
Zhu, N. “The Local Bias of Individual Investors.” Working Paper, University of California at Davis (2002).CrossRefGoogle Scholar