Investors, Investment Strategies and Regulation Flashcards
Previous theories and models took as assumptions that investors thought alike. Is that realistic?
No. People behave differently, are very heterogeneous, even if they look like they might think the same
Studies about investors’ decisions classify the investors into two categories. Which are them?
-individual investors
-institutional investors
What are the main reasons for individual investors to trade?
1) information reasons -> when the benefit of doing so is greater than its costs - information migh be a major motivation
2) rebalancing reasons - may need to trade to rebalance their portfolio
3) life cycle hypothesis - in the initial period of life people essentially tend to borrow, and over time the situation changes
4) tax motivations - at the end of the year taxes become more important. Investors tend to delay the sell of winning stocks to pay taxes later. Also, by the end of the year investors tend to sell losing stocks ‘cause it will compensate previous wins
5) behavioral explanations - like overconfidence hypothesis or social reasons, like the participatios of their peers
Regarding behavioral explanations for individual investors to trade, what are the main conclusions of the overconfidence hypothesis?
Investors may trade too much because they are overconfident about their skills;
-investors that trade more tendo to have lower returns -> more fees and comissions
-women tendo to outperform men because they are less overconfident
Regarding behavioral explanations for individual investors to trade, what are the main conclusions of the salience hypothesis?
Investors tend to buy stocks that grab their attention, due to hard surch among thousands of stocks
Regarding behavioral explanations for individual investors to trade, what are the main conclusions of the flawed information hypothesis?
investors misinterpret information making more significant mistakes that influence prices
What patterns in individual investor’s decisions were presented?
1) disposition effect
2) home bias
3) ability to learn by trading
4) cross-sectional variation in performance
Regarding patterns in individual investor’s decisions, what is the disposition effect about?
The tendency to hold on to losing stocks for too long while selling winning stocks too early - don’t like to admit mistakes - effect motivated by behavioral reasons; doesn’t only affect individuals
How does the disposition effect vary?
-It decreases with experience and trading frequency and increases with social interactions
-Stronger among stocks that are more difficult to value - i.e. stronger with high idiosyncratic risk
- Effect is reverse in case of a loss under high volatility
Regarding patterns in individual investor’s decisions, what is the home bias about?
Individuals tend to invest in companies geographically and culturally closer to them - probably due to having more information which may help get higher returns; this also migh be partially due to currency risk and turnover rates
What seem to be the main reasons for home bias?
1) information reasons - have better knowledge about domestic companies
2) asymmetric news coverage - local media might focus a lot on local companies and in a favorable way, helping attract investors
3) behavioral reasons - more positive attitudes towards familiar stocks
Regarding patterns in individual investor’s decisions, what is the learning by trading about?
If investors are capable of learning, maybe they’ll improve their performance. Although, they learn from their experience, so stronger individuals will over all better their perormance
What are some counter arguments about learning by trading?
-there are always new investors entering the markets
-mistakes and lack of feedback prevent learning
Regarding patterns in individual investor’s decisions, what is the cross-sectional variation in performance about?
individual investor trading results in systematic and economically large losses - this is predictable and can be traced to investment skills, education, etc
What is the difference between dumb investors and smart investors?
Portfolio distortions of smart investors reflect informational advantage generating high-risk adjusted returns, while portfolio distortions of dumb investors arise from psychological biases because those investors have a low risk-adjusted performance - although either dumb or smart they ahve the same behavior (just for different reasons)