Week 5 - – Barberis & Thaler (2003): Direct investments of individual investors

Question 1

What is the main idea of this paper?

Answer 1

• What kind of portfolios do they (investors) hold and how they trade over time
• Application to behavioural finance: (1) insufficient diversification; (2) naïve diversification; (3) excessive trading; (4) the buying decision: attention effect; (5) the selling decision: disposition effect
• (1) Investors diversify their portfolio holdings much less than is recommended by normative models of portfolio choice. They also overweigh assets from their home country or location. expose investors to idiosyncratic local risk that is likely correlated with their jobs.
• (2) Many investors seem to use strategies as simple as allocating 1/n of their savings to each of the n available investment options, whatever those options are
• (3) It is hard to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Individuals who trade the most, perform the worst.
• Overconfidence explanation: Overconfident investors believe that they have private signals strong enough (level and/or precision) to justify a trade, whereas in fact the information is too weak to warrant any action.
• (4) Attention effect: Rather than searching systematically through the thousands of listed shares until they find a good buy, but many investors choose from a set of stocks that has caught their attention.
• Does media coverage of individual stocks influence trading of retail investors? Local media coverage increases local trading volume by 37% to 75%.
• (5) Disposition effect (Shefrin and Statman 1985): Investors prefer selling stocks that have increased in value since bought (winners) relative to stocks that have decreased in value since bought (losers).
• Behavioural explanation: irrational belief in mean reversion and narrow framing (every stock is evaluated separately)