Individual Investors II - Articles

Question 1

What are the main findings in the Article by Barber & Odean (2000)?

Answer 1

1. Study shows that individual investors who hold common stocks directly pay a tremendous performance penalty for active trading (-6%)
2. Overconfidence is the main reason for poor performance.
3. Paper supports view that overconfidence leads to excessive trading
4. Average households tilt their investments toward small, high beta stocks.

-> overall: Trading is hazardous to your wealth!

Question 2

What are the two competing theories of active trading that are test in the paper by Barber & Odean (2000)? And are these two models supported by findings?

Answer 2

1. Grossman-Stiglitz-Model / “Rational expectation”
   -> predicts that investors will trade when the marginal benefit of doing so is equal to or exceeds the marginal cost of the trade. Therefore, investors who trade more will have higher gross risk-adjusted return.
   ->not supported by evidence: those trading more do not earn higher gross return
2. Overconfidence model
   -> investors suffer from overconfidence that has detrimental consequences
   -> predicts that investors who trade more will have lower expected utility
   -> supported by evidence!

Question 3

What are the reasons for the findings in the Barber & Odean (2000) paper?

Answer 3

1. Households trade common stock frequently.
2. Trading costs are high
3. Households tilt their investment toward small, high-beta stocks.

Question 4

What could be other possible explanations for increased trading behavior in the Barber & Odean (2000) Paper?

Answer 4

1. Liquidity
2. Risk Rebalancing
3. Tax-motivated trading
4. Gambling / Entertainment

-> other possible reasons cannot fully explain high frequency trading, only to some extent!

Question 5

What are the main findings in the Dorn & Sengmueller (2009) paper?

Answer 5

1. Entertainment driven investors turn over their portfolio at roughly twice the rate of their peers -> higher turnover.
2. The qualitative benefits (emotional + expressive) of trading surpass the cost for active trading.
3. Self-professed gambler tend to be younger, less educated and less wealthy.

Question 6

What motivated (wants) trading in the article by Dorn & Sengmüller (2009)?

Answer 6

1. Recreation -> motivated by a feeling of accomplishment or as byproduct of hobby
2. Sensation Seeking -> novelty through high volatility attached to undiversified portfolios -> value act of trading
3. Aspiration of Riches -> lottery, abandon trading ideas more quickly than peers

Question 7

What are the overconfidence measures used in the article by Dorn & Sengmüller (2009)?

Answer 7

1. Overestimation / Better-than-average effect
2. Illusion of control
3. Self-attribution bias

Question 8

What is self-attribution bias?

Answer 8

=individuals tendency to attribute success to personal skills and failures to factors beyond their control

Question 9

What are the two hypothesis tested in the paper by Hoffmann & Post (2014)?

Answer 9

H1a -> positive relationship between investment returns in a given period and investors agreement at the end of the period with a statement claiming that their recent performance reflects their personal investment skills
->confirmed

H1b -> only individual-level investment returns affect investors agreement with the above-mentioned statement, while market returns have no such effect
->confirmed

Question 10

What are the main findings in the article by Hoffmann & Post (2014)?

Answer 10

-The higher previous period’s returns are, the more investors agree with a statement claiming that their recent performance accurately reflects their investment skills
-While individual returns relate to such an agreement, market returns do not

Question 11

How can the self-attribution bias be tackled?

Answer 11

• Online decision-support systems
• Adoption movement towards fee-based model for financial advice
• Provision of high-quality, independent financial advice through a user-friendly (online) interface