Why%20Do%20Individuals%20Exhibit%20Investment%20Biases? - PowerPoint PPT Presentation

About This Presentation
Title:

Why%20Do%20Individuals%20Exhibit%20Investment%20Biases?

Description:

Why Do Individuals Exhibit Investment Biases? Henrik Cronqvist Claremont McKenna College Stephan Siegel University of Washington National Taiwan University – PowerPoint PPT presentation

Number of Views:125
Avg rating:3.0/5.0
Slides: 23
Provided by: Foste8
Category:

less

Transcript and Presenter's Notes

Title: Why%20Do%20Individuals%20Exhibit%20Investment%20Biases?


1
Why Do Individuals Exhibit Investment Biases?
Henrik Cronqvist Claremont McKenna
College Stephan Siegel University of Washington
National Taiwan University International
Conference on Finance December 6, 2012
2
Genes and Household FinanceResearch Agenda So Far
More risk
Participate in stock market
Investment biases
Today
Save
Less risk
Dont participate in stock market
Investment styles value vs. growth
Consume
  • We use twin study research design to examine, for
    each of the above choices, the effects of i)
    genetic and environmental influences, and ii) GxE
    moderators.
  • Parallel to molecular genetics and
    neuroscientific studies by Camerer, Bossaerts,
    Kuhnen, Laibson, Zak, and others.

3
Investment Biases
  • Long list of investment behaviors that cannot be
    explained by standard preferences and belief
    formation
  • Underdiversify
  • Prefer local securities home bias
  • Avoid realizing losses
  • Trade a lot
  • Chase past performance
  • Prefer lottery-type stocks
  • Some of these behaviors have been shown to be
  • Wide-spread present also among professional
    investors
  • Related to fundamental psychological mechanisms
  • Costly
  • But, degrees of behavior vary across investors

4
Biological Basis for Investment Behaviors
5
Existing Evidence
  • Experimental evidence (previous slide)
  • Capuchin monkeys exhibit loss aversion
  • Capuchin monkeys prefer gambles with good
    outcomes framed as bonuses over identical pay-off
    gambles with bad outcomes framed as losses
  • Loss aversion is part of decision-making process
    that evolved before humans and capuchins
    separated (Chen et al. (2006), Lakshminarayanan
    et al. (2011))
  • But No empirical evidence on the genetics of
    investment biases based on real world financial
    decisions and data

6
Research Methodology Twin Researc
Identical Twins
Fraternal Twins
Josefin and Elin Nordegren
The Hodgson Twins
7
Intuition of Methodology
  • Use identical fraternal twins to decompose the
    variation in investment behaviors
  • Identical (monozygotic, MZ) twins share 100 of
    their DNA
  • Fraternal (dizygotic, DZ) twins share on average
    50 of their DNA
  • Twins who grew up in same family share a common
    environment
  • Each twin has his/her individual (non-shared)
    environment

If genes matter, then identical twins should be
more similar than fraternal twins in terms of,
e.g., their investment behaviors.
7
8
Methodology
  • Random effect model with genetic effect a, common
    effect c and individual-specific effect e
  • Covariance structure implied by genetic theory

9
Methodology, contd
  • Estimate parameters s2a, s2c, and s2e via maximum
    likelihood estimation (MLE) with bootstrapped
    standard errors
  • Derive the variance components

A-share genetic component C-share common
environment (parenting) E-share individual
environment measurement error
10
Data
  • Swedish Twin Registry
  • Matched with annual financial data (including
    holdings of assets and sales transactions) and
    socioeconomic data from Statistics Sweden (1999
    2007)
  • Filters
  • At least 18 years old
  • Both twins hold some equities (directly or
    indirectly) in one year
  • Average all variables over the years that
    individual is in sample

11
Measuring Investment Biases
  • Diversification
  • Number of stocks in portfolio
  • Home Bias
  • Proportion of equity portfolio in local
    (Swedish) equities
  • Turnover
  • Annual sales volume scaled by value of portfolio
    at beginning of year
  • Disposition Effect
  • Proportion Gains Realized (PGR) Proportion
    Losses Realized (PLR) (Odean (1998))
  • Performance Chasing
  • Proportion of equities acquired with raw returns
    in top two deciles
  • Skewness Preference
  • Proportion of lottery securities (Kumar (2009))

12
Evidence from Correlations
13
Variance Decomposition
14
Variance Decomposition
15
Robustness
  • Opposite-sex twins
  • Model misspecification
  • Allowing for negative variance components
  • Communication
  • Identical twins communicate more with one another
  • Financial decisions are influenced by
    communication (e.g. Shiller and Pound (1998),
    Hong, Kubik, and Stein (2004))
  • Sort pairs into 10 communication intensity bins
    and randomly drop identical/fraternal pairs until
    both types are equally often present per bin.
    Estimate model across all 10 bins.
  • A component is somewhat reduced, but overall,
    results are robust.
  • Equal environments assumption

16
Identical Twins
Unrelated Look-Alikes www.francoisbrunelle.com
17
Two Additional Results
  • Moderators of genetic investment biases
  • Behavioral consistency Investment biases and
    behaviors in other, non-investment, domains

18
Moderating Genetic Effects
  • Environment can enhance or reduce the effects of
    genetic predisposition
  • Example Education seems to reduce genetic
    variation in health outcomes (Johnson et al.
    (2009))
  • Examine how years of education interact with the
    genetic effects
  • No significant evidence that years of education
    reduces genetic predispositions to investment
    biases

19
Moderator Years of Education
20
Financial Experience
  • Does work experience in the financial industry
    or, e.g., in a corporate treasury department
    reduce genetic predispositions to investment
    biases?
  • Repeat analysis for individuals working with
    finance
  • A components reduced (generally by gt50).
  • Experience in the finance industry seems to
    reduce the genetic predisposition to investment
    biases.

21
Behavioral Consistency
  • Behavior across different domains is often
    consistent
  • If genetic factors matter, source of consistency
    should be genetic
  • Correlate Home Bias with
  • Distance to birthplace
  • Indicator whether spouse is from same home region

22
Behavioral Consistency
23
Conclusions
  • A long list of investment biases are human in
    the sense that investors are born with
    pre-dispositions
  • ?25-50 of variation explained by genetic
    variation
  • Provide empirical support for evolutionary models
    of investment biases (e.g., Brennan and Lo
    (2009))
  • Education does not reduce the genetic
    predisposition to investment biases. But finance
    industry experience reduces genetic effects.
  • Genetic factors influencing investment biases
    affect behaviors in other, non-investment,
    domains.

24
Why Are Investment Behaviors Genetic?Why Are
Some More Genetic Than Others?
  • Nature selects behaviors that are fitness
    maximizing.
  • Several recent models show that non-standard
    preferences are indeed fitness maximizing e.g.,
    Rayo and Becker (2007), Brennan and Lo (2009).

25
Public Policy Implications
  • Do the results of significant genetic effects
    make public policy initiatives irrelevant in the
    domain of household finance?
  • No.
  • But policy should be designed assuming that
    individual investors exhibit investment biases,
    rather than based on a notion that biases may be
    easily educated away or otherwise eradicated in
    markets (Cronqvist and Thaler (2004)).
Write a Comment
User Comments (0)
About PowerShow.com