Investor Behavior slides

Question 1

Discrimination

Answer 1

when a member of a minority group is treated differently than if they were a member of a majority group.

Question 2

Hiring Discrimination

Answer 2

-there was a change in the audition procedure for symphony orchestras concealing identity (increased the chance women would be hired and advanced)
-Another example is female names in a female dominated industry such as waitstaff or sales, Where female sounding names get more callbacks than males
- Black sounding names got 50% less callbacks than white sounding names and higher resume quality mattered more for white applicants than black applicants.

Question 3

Wage Discrimination

Answer 3

-25% gap in the earnings of white and black people
-Much larger in the 70s but it fell by a factor of 2
- Due to: Anti discrimination legislation and education: an example was the FLSA which enacted the federal minimum wage which primarily impacted black dominated sectors such as agriculture. Helping get rid of pay disparity in those specific industries.

Question 4

Mandating Equality

Answer 4

-2006 Norway implemented a law that mandated equal male and female seats on corporate boats. This lead to negative consequences on both profitability and stock prices. These results could be short terms and due to lack of experience.
-Local Indian elections: Councils are randomly selected by council forcing female leaders into positions of power. After one cycle more females run and win for unreserved seats.
-Affirmative action: Black people make up 15% of the college aged population but only 6% of freshman. Controversial as it doesn’t take into account all factors and is based on race

Question 5

Forced interaction reducing discrimination logic

Answer 5

-Random roommate assignment at UCT reduced prejudice for those placed with minority roommates. There is evidence that majority group members become more demanding of social change where minority members become less demanding of social change.

Question 6

Role Models

Answer 6

-Seeing someone in your demographic in power increases your perceived likelihood of achieving that position. The example of Indian villages with women in power led to females more likely to stay in school and parents to have higher aspiration for their daughters.
-Exposure to a non-stereotypical CS role model and seems normal increases female subjects believing they could succeed in the field although it is a male role model.

Question 7

Housing Returns

Answer 7

-Compared to single men, single women spend 2% more when purchasing a house and get 2% less when it comes time to sell.
-Another example is black and Hispanic residents face a 10-13% higher tax burden for the same bundle of public services. Property assessments are less sensitive to neighborhood attributes than market prices are. appeals behavior and outcomes differ by race

Question 8

Redlining

Answer 8

Discriminatory practice that puts services out of reach for residents of certain areas (uses the credit worthiness of the area rather than the individual). Redlined neighborhoods had a 5% lower home price than adjacent areas decades after redlining was outlawed.

Question 9

Loan Requests in Chile

Answer 9

-An experiment in Chile showed that approval rates for female borrowers is 18.3% lower than similar males. There was no significant change when they were informed that females pay off loans better than males on average. This is as borrowers who appear more trustworthy have a higher probability of getting their loans funded on prosper. Trustworthiness does predict default rates

Question 10

Quality of Financial Services

Answer 10

in the incidence of fraud, mis-selling and poor customer service, there was a one standard deviation increase in minority population leading to a 16% increase in complaints effect for area income is 2% and education is 6%
- Community Reinvestment Act (CRA) Designates certain census tracts and underserved if the average income of the area is less than that of 80% of the median income of the metropolitan area. Banks that fail to lend enough to these areas will receive repercussions. (CRA areas have 32% more complaints as there is not an increase in quality just quantity)

Question 11

Financial Misconduct

Answer 11

There is a gender punishment gap. Following an incident of misconduct female advisers are 20% more likely to loose their jobs and 30% less likely to find new work. Women face harsher outcomes despite engaging in behavior that is 20% less costly. Not jus true for women AA and Hispanic people face higher penalties for the firm despite being more likely to receive disclosures than their white male counterparts.

Question 12

How does this change with group bias?

Answer 12

The gender punishment gap is smaller when there are more female managers and more minority male managers mitigate the minority punishment gap among male advisors.

Question 13

What are the kinds of discrimination?

Answer 13

Some employers simply do not like the members of these minority groups. Some employers believe they are less capable. In perfectly competitive markets this would disappear as they would not be able to compete as they would not get the best talent. It can be reversed with a sequence of positive ratings as at first there is significant discrimination and after many positive evaluations the direction of discrimination reverses.

Question 14

Why do Americans tend to under-save?

Answer 14

As 100 million do not have any retirement account, 77% fall short of retirement targets for their age. Median balance is 0. this can be explained by present bias and hyperbolic discounting.

Question 15

Non-participation in the stock market.

Answer 15

Surprisingly low number hard to explain traditionally. This can be because of prospect theory, ambiguity aversion, and trust. Investors are loss averse similar to the Equity premium argument. Probability weighting makes the stock market less appealing (negative skew.) If you are trusting more likely to invest in the market.

Question 16

Anti-Semitism and Trust

Answer 16

Historically Jews in Europe have specialized in the financial services sector. Finance demand is lower where there was historically higher levels of anti-semitism as they trust the Jews less than other counties.

Question 17

Nature or Nurture

Answer 17

Studying twins a large component is attributed to genes but there is some factors in how you are raised.

Question 18

Home Bias

Answer 18

There is a lack of logic in many individuals as they refuse to short of underweight home country stock to hedge out risk. Individuals often invest heavily in domestic stocks ignoring the benefits of diversification. Preference for the familiar and we feel patriotic.

Question 19

Local Bias

Answer 19

Within our domestic holdings we tend to tilt our portfolio towards locally headquartered stocks. Familiarity playing a role here as we understand and see the business commonly.

Question 20

Concentrated Holdings

Answer 20

• Many households have a very concentrated position in a few stocks. Some plausible explanations are overconfidence in one’s analysis of a company, Decision weighting want to have a large position in a lottery stock to have a chance at becoming wealthy. Non-belief in Law of large numbers: People over estimate the chances of extreme outcomes in large samples.

Question 21

Large Holdings of Own Company Stock

Answer 21

-20-40% of discretionary funds into an employers company stock
-Due to familiarity and loyalty

Question 22

What is important for Investor Beliefs?

Answer 22

Memory and salient events are important for beliefs and holdings. Recent and dramatic episodes are correlated with return expectations.

Question 23

Climate Change and Investments

Answer 23

In abnormally high temperatures people pay more attention to global warming. Retail investors sell carbon intensive firms in these times leading to low carbon stocks out preforming at these times. Due to salience and availability of the temperature change

Question 24

Naive Diversification

Answer 24

Investors in DC plan to use a rule of thumb using a conditional 1/n rule of funds they equally invest into. The more equity funds offered the higher the equity investment. Bounded rationality: diversification is good but hard to achieve.

Question 25

Trading and Wealth Returns

Answer 25

Individuals do a poor job actively investing and trading. Underperforms start of year portfolio and market, Also underperform a CAPM benchmark. This is without including trading costs or any of the risks previously mentioned in the arbitrage section. This is due to overconfidence as they believe they are above average. Overconfident investors trade more and those with positive past performances also trade more. This tends to be seen more in males than in females. Males trade more often and are more overconfident in their abilities. Stronger for more traditional gender norms and when it is more salient for gender roles.

Question 26

Sensation Seeking

Answer 26

In Finland the fine for moving violations is a function of their yearly income. Measure the sensation seekers as those with speeding tickets, sensation seekers trade more often. Craving novel, intense, and risky experiences.

Question 27

Market Timing

Answer 27

Individuals increase exposure when there are high values and reduce exposure when it is at a low. this is due to an over-extrapolation of recent trends. As the return on mutual funds is lower than the time weighted return on average.

Question 28

Do Investors Care about sustainability?

Answer 28

Yes as being categorized as low sustainability lead to net outflows of more than 12 billion and high sustainability rating led to 24 billion more inflows.

Question 29

Disposition Effect

Answer 29

Investors have a greater propensity to sell at a gain rather than a loss. an example is house prices as seller tend to insist on receiving at minimum what they paid for it. (Longer time on market and lower probability of being able to sell). Rationally winners sold and out preform the losers that held. More pronounced in less sophisticated or educated investors.

Question 30

Explanation for Disposition Effect with Behavioral Finance

Answer 30

This is due to the fact that people when they realize a gain feel positive utility and pain from asset at a loss. People think of investing as an episode and this is a very memorable and salient one. -Cognitive Dissonance: It is hard to admit the previous purchase decision was a mistake. Social pressure also can exacerbate this it is hard to admit to your peers that you are wrong and it is pleasurable to be able to recount victories.

Question 31

Insider Trading (disposition effect)

Answer 31

Insiders must file trades with the SEC, purchases are strong positive indicators for future returns but sales have very weak predictive power.

Question 32

Mental Accounting (disposition Effect)

Answer 32

On reinvestment days investors have no disposition effect, When a stock is sold at a loss the reinvestment will have a higher variance which is consistent with the fact it is automatic and not emotionally driven. Mutual funds exhibit a larger disposition effect when outflows prevent them from rolling accounts.

Question 33

The rank effect

Answer 33

Probability of sale with controls, similar pattern when you order a portfolio alphabetically, this is due to salience as more extreme positions are memorable.

Question 34

Intelligence and Trading Returns

Answer 34

-Those that preformed better on an SAT or ACT tend to average higher returns. -Finnish armed forces gives an intelligence test to recruits and those who score higher on average have higher returns than those who preform poorly (due to less subjected to disposition effect, more aggressive tax loss trading, less herding, and mitigate trading costs)

Question 35

Dividend Investments

Answer 35

does not really make sense why they are liked. Tax disadvantages especially before 2003. They seem like "free money", self control (mental accounting), and trust. -Mental accounting completely separate from the return (free money) -Self Control as you are able to consume out of your dividend checks giving you an income. Older people bias towards these stocks.

Question 36

Why do investors perceive dividend paying funds as less likely to commit accounting fraud?

Answer 36

Gives a feeling of legitimacy in the distribution of cash. If one of a Mutual funds investments commit accounting fraud they give more capital to dividend payers. Dividend premium is the valuation of dividend payers relative to non dividend payers. This increases when there are local fraud events.

Question 37

Life Annuity Insures against longevity risk

Answer 37

You give a lump sum and receive a long sting of payments as long as you are alive that is higher than what could be sustained. You give up the principle at death. Principal of early deaths fund the later ones. They are not very popular with 1% of households wealth having money in private market annuities.

Question 38

Social Security and Age

Answer 38

You can get more social security as you age by delaying when you claim benefits. Average person gets higher lifetime payments by delaying as the government uses out of date mortality tables. Only 1/10 men retiring before their 62nd birthday delay claiming social security benefits for more than a year.

Question 39

Using behavioral finance terms why are annuities under utilized?

Answer 39

Adverse Selection: Those who have health issues will avoid them while those who are healthy might lean towards them. Self selecting. A desire to remain in control of ones funds Loss aversion for an early death if you pass early

Question 40

Property and Casualty Insurance

Answer 40

Individuals tend to not buy enough insurance against catastrophic risks such as floods and earthquakes. When there is flooding in a nearby county there is a 3% take up in flood insurance due to availability of news.

Question 41

Lotteries

Answer 41

Lottery sales were over 100 billion last year alone. This is due to the decision weighting part of prospect theory which over weights low probability outcomes. Our utility function has 2 arguments good that are costless to adjust and those that are costly to adjust.

Question 42

Housing and Climate Change

Answer 42

Average household has more wealth tied up in real estate than any other asset class. by 2100 2% of houses will be underwater. There is a strong heterogeneity about climate change as less than half Americans believe that global warming will pose a serious threat to how they live.

Question 43

Rental Choices when moving cities.

Answer 43

When moving from a high cost of living city to a lower one people tend to get a more expensive apartment or the inverse if moving from a low to high. This is due to availability and anchoring from the previous city.

Question 44

Social Housing Investment

Answer 44

Geographically distant friends are more likely to buy if their friends in another state had a large housing price surge. Making it look like a more attractive investment.

Question 45

Mortgage advertising

Answer 45

Advertise more where they are able sell more expensive mortgages, effects on initial introductory rates are stronger on less sophisticated investors.

Question 46

Strategic Defaults

Answer 46

-Few walk away from a home when equity is negative. only 23% would walk away if the negative equity exceeded 100k. -This is due to the cost associated with moving -82% of people think it is immoral and women are 41% less likely to strategically default

Question 47

Determinants of who will strategically default

Answer 47

-Who are angry at their situation or trust banks less are more likely to default. Someone who knows a person who did it. Older people above 65. If you believe unemployment is nearing.

Question 48

Growing up without finance

Answer 48

in 1953 congress passed a law having state court enforcement of deby on a subset of reservations. expansion of banking activity they are 20% more likely to have a thin or missing credit report and 18 points average lower credit score. Less likely to convert applications into loans.

Question 49

Credit Card Defaulting

Answer 49

In an experiment for an Islamic bank they sent a message that nonrepayments of debt when you can is an injustice" -The moral appeal decreases delinquency by 4.4% from a baseline of 66% default among customers with the highest credit risk

Question 50

Social Collateral

Answer 50

In a Vietnamese experiment borrowers are randomly chosen to have their repayment status shared with an observer (one of their social connections) decreased delinquency by 19% off base rate. Stronger for single men than married men.

Question 51

Conspicuous consumption

Answer 51

Visible Consumption: Observable in social situations and easily portable across situations Ex: cars It is what outsiders draw status from. Perceived income is based on spending on visual consumption. Blacks and Hispanics spend more on visible consumption than similar white counterparts. (controlling for average income fixes most of the difference)

Question 52

consumption and payday

Answer 52

spend more on the days they get paid retailers take advantage of this raising prices at the start of the month

Question 53

YOLO

Answer 53

Younger individuals overestimate mortality. Survival chances are much higher than they believe as the rare events associated with death are overweighted large survival belief errors are associated with greater propensity to not save and rely on credit cards.

Question 54

How do individuals form inflation expectations?

Answer 54

Rely on price changes from their day to day bundle. Frequency of the purchase instead of the size of the expenditure. Positive price changes seem to have a bigger impact than similar sized negative price changes.

Question 55

Can the stock market make you sick?

Answer 55

Yes it can as seen on Oct 19th when the Dow plunged 22%. Due to anxiety, panic, and major depression. Negative correlation with hospital admissions.

Question 56

Higher debt and Job choice

Answer 56

With higher levels of debt workers take higher wage jobs they don't love with lower satisfaction.

Question 57

Populism and Financial Swings

Answer 57

Populists claim to speak for all the people against the elite. Crisis leads to increased support for populism.

Question 58

Bertrand Equilibrium

Answer 58

It is a pricing theory. It assumes perfect information, no transaction costs and that firms produce at the same marginal cost. We start at MC

Question 59

Index Fund Fees

Answer 59

Index funds that replicate the S&P 500 are generally associated with low fees  Wide variation in the fees charged for these funds.  Fidelity has an index fund that charges 0 percent.  The Rydex S&P fund has charged around 2 percent in recent years

Question 60

Cooperation

Answer 60

The following trigger strategy by each firm, don't lower prices provided the fact the rival hasn't either. If a rival undercuts start a war to your MC. Condition is that profit from cheating

Question 61

Implicit Conclusion (Infinitely repeated game)

Answer 61

Collusion can be sustained as a Nash Equilibrium when there is no end to the game. This requires the ability to monitor actions of rivals, punishing of defectors, low interest rate and high probability of future interaction. Hard to do this with many different firms

Question 62

Roles of Brokers and Search Costs

Answer 62

-in 2010 56/100 Americans sought investment advice from a financial professional. they are sometimes incentivized to sell inferior products. -although all consumers of these convertible bonds would be better off purchasing the superior 11.25% convertible bond consumers pent 10 times as much on the 9% product as there was a higher fee on the 9% bond at 3% compared to 2.15%

Question 63

Why and how do investors demand that brokers get paid?

Answer 63

All else being equal investors tend to demand procducts that are less risky and have higher coupons controlling for broker fees, demanding a higher implied value. Demand is shown to increase with broker fees.

Question 64

Strategic price complexity

Answer 64

-Partitioning pricing into direct and indirect parts -New technical language -Inventing new fees other firms don't use -Using footnotes -Will argue the mechanism keeps market power.

Question 65

Simple Complexity Model

Answer 65

-Some investors are informed and pick the best products available -Some are uninformed and pick products randomly -Firms produce the same product and have to decide on pricing - A Bertand Equilibrium is not possible as uninformed investors make setting p>MC a dominant strategy -We also cannot have one price equilibrium as if P>MC you would be incentivized to undercut competitors to gain the sophisticated investors.

Question 66

As the number of firms grow does complexity increase?

Answer 66

The answer is yes as each firm's chances of winning business decreases. Each firm will increase complexity to make more randomly picking consumers increasing expected profits. Perfect competition: Maximum complexity. Prices may rise as the fraction of experts will decrease.

Question 67

Do Unsophisticated investors suceed?

Answer 67

The answer is more complex contracts for less sophisticated customers. Annual return is lower for more complex contracts.

Question 68

Are politicians confusing voters?

Answer 68

Structured loans are a popular form of borrowing for governments  Long maturities, fixed interest rates for the first years of the loan, and an adjustable rate that depends on the value of a financial index (e.g a foreign exchange rate)  Representatives from financially distressed local governments are much more likely to turn to structured loans  Incumbents running in politically contested areas are more likely to use structured loans (rise in structured loans before elections)  Issuing structured loans helps politicians get re-elected (funds received from restructuring are used to lower taxes)  Politicians with more education are more likely to use structured loans  Takeaway: Politicians seemingly choose complicated products as a way to take on “debt” without voters knowing.

Question 69

Juicing Dividend Yields

Answer 69

Costs of closet juicing are very difficult for investors to observe  Look to see if actual dividends>implied dividends  Excess dividend ratio = Actual dividends/implied dividends  5.3 percent of all fund-years have an excess dividend ratio>2!  Juicing funds have higher dividend yields, higher flows, higher turnover, and lower returns  Management somewhat rewarded for juicing

Question 70

Can Security Design help?

Answer 70

 Capital guarantee products (CGP) are equity linked products that offer capital protection  Within 5 years of their introduction in Sweden, they reached 14% of the population  Allow investors to access about 44% of the equity premium despite having markups that average 1.6% per year The fast and broad adoption of these products is associated with an increase in expected financial portfolio returns, which is especially strong for households with a low risk appetite