Week 3 - Individual investors

• Transaction cost:

  • commission/fees to brokerage
  • bid-ask spread:
    • when buying, pay ask price
    • when selling, pay bid price

• overview of individual investor performance

  • 
  • 
    • in () = p value. only stat. significant if < 0.05
    • average household: benchmarked against simpling holding: no difference
    • CAPM: no difference
    • 3-factor - alpha also not stat. significant
      • tilt towards value (positive coeff)
      • tilt towards SMB (institutional tend to do more large stock) - which tends to have higher bid-ask spread -> more transaction cost
  • once taken into account of transaction cost, average household under perform against the benchmarks

• loss aversion

  • assymetry:
    • tend to hold on to stock with losses (expected utility of selling is worse than holding)
    • tend to capture gains
  • loss-aversion good or bad?
    • go against momentum effects
    • against tax incentives
      • loss aversion effect is stronger in tax-deferred accounts (in regular accounts, the tax incentive reduces the loss aversion effect) - so tax motivation still matters
  • personal connection to asset
    • emotional connection: house
    • Genesove and Mayer(2001):
      • if house has fallen value since purchase:
        • takes longer to sell
        • effect 2x for owner-occupants
    • having someone to blame affects trading
      • 
      • effect is reversed for mutual funds - loss -> more likely to sell - tax effect more important, easy to blame the fund manager
  • impact on corporate finance decisions
    • firm acquisition:
      • offer's chance of success jumps discontinously when offer price exceeds past 52-week peak
    • equity issuance (sell stock to raise cash):
      • influenced by the stock price when a CEO joined the firm -> suggest a firm with past poor stock return may need to fire current CEO if they wish to raise cash by selling equity
  • explanation for momentum?
    • when the stock goes up with good news, the cashing-in effect dampens the initial price increase
    • when stock goes down with bad news, the hold effect dampens initial drop
  • Importance of endowment effect
    • endowment effect:
      • people given coffee mug and asked if they would trade it for chocolate. 89% keep the mug
      • initially given chocolate, only 10% wants to trade it for mug
      • given both choices at start, 56% choose mug
    • tax witholding
      • emotion on tax day: less upset with the witholding model
      • benchmark: after-tax income
    • credit card
      • current vs future wealth
    • annuities
      • current wealth vs future consumption
  • emotions and financial decisions
    • are psychopaths best investors? - shiv, et al 2005
      • factors:
        • loss aversion: more likely to invest after losing last round
        • house-money effect: more likely to invest after winning
        • representatives: more likely to invest after winning
      • 

• Skill of individual investors?

  • local investments
    • on average, household allocate 1/3 to local stocks (hq within 250 miles) vs 1/8 if spread evenly
  • concentrated accounts with 1 or 2 stocks (especially wealthy households) seems to have better information than more diversified:
    • 
  • 
    • various robustness tests
      • after excluding stocks with certain characteristic, result still hold