Behavioral Finance and Asset Pricing
Friday, Jan. 7, 2022 10:00 AM - 12:00 PM (EST)
- Chair: Samuel Hartzmark, University of Chicago
AbstractThis paper is the first to study the cross-section of currency excess return predictors to explore alternative explanations for their existence. Using real-time data, quantitative currency trading strategies are profitable during in-sample and out-of-sample periods, even after transaction costs and comprehensive risk adjustments. However, (risk-adjusted) profits decrease substantially after the publication of the underlying academic research. In line with predictor profits reflecting mispricing, the decline is greater for strategies with larger in-sample profits and lower arbitrage costs. Moreover, the effect of risk adjustments on trading profits is limited, and signal ranks and alphas decay quickly. While analysts’ currency forecasts are inconsistent with currency predictors, analysts update their forecasts quickly to incorporate lagged predictor information. The results suggest that market participants learn about mispricing from academic publications, while contributing to it when following analysts’ forecasts.
Risk Aversion Propagation: Evidence from Financial Markets and Controlled Experiments
AbstractWhile the time variation in investor risk appetite is widely examined, there is scant research on how investor risk appetite may respond in an international context. We study risk aversion (RA) propagation from US to other major developed economies using both financial market data and controlled experiments. By exploiting daily financial market and news data between 2000 and 2017, we identify US risk aversion events -- both high and low -- and show that the international pass-through of US high RA events is significantly higher (61%) than that of US low RA events (43%), suggesting asymmetric US risk aversion propagation. Next, in our experiment, non-US subjects when primed with a US financial bust shock exhibited asymmetrically lower positive emotion, higher negative emotion and higher risk aversion than those primed with a US boom shock. The foreign nature of negative shocks may change emotions more than that of positive shocks, hence resulting in asymmetric risk aversion propagation. Our evidence shows that such an ``emotion'-related mechanism explained up to 20% of the asymmetry.
Can Agents Add and Subtract When Forming Beliefs? Evidence from the Lab and Field
AbstractWe study an intrinsic property of Bayesian information processing which does not rely on individuals having rational absolute beliefs: two equally-diagnostic signals of opposite direction should cancel out. Using evidence from both the lab and field, we show that individuals not always follow this counting-based principle. Systematic violations occur whenever a sequence of identical evidence is interrupted by a signal of opposite direction, which produces strong and robust overreactions. Conversely, individuals correctly follow this counting-based principle whenever signals alternate while they underreact to sequences of same-directed evidence. Next, we empirically analyze announcement and post-announcement stock return reactions in financial markets. Consistent with our experimental evidence, we find that initial stock reactions are significantly stronger and subsequent price drifts weaker for opposite-directed earnings surprises than for same-directed earnings surprises. Our results provide novel insights to the paradoxical co-existence of over- and underreaction to new information at the individual and market level.
- G3 - Corporate Finance and Governance