Behavioral Finance

April 20, 2013
Andrei Shleifer, Harvard University, and Luigi Zingales, University of Chicago, Organizers

Nicola Gennaioli, CREI; Andrei Shleifer; and Robert Vishny, University of Chicago and NBER

Money Doctors (NBER Working Paper No. 18174)

Gennaioli, Shleifer, and Vishny present a new model of investors delegating portfolio management to professionals based on trust. Trust in the manager reduces an investor's perception of the riskiness of a given investment, and allows managers to charge fees. Money managers compete for investor funds by setting fees, but because of trust fees do not fall to costs. In equilibrium, fees are higher for assets with higher expected return, managers on average underperform the market net of fees, but investors nevertheless prefer to hire managers to investing on their own. When investors hold biased expectations, trust causes managers to pander to investor beliefs.

John Chalmers, University of Oregon, and Jonathan Reuter, Boston College and NBER

What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes? (NBER Working Paper No. 18158)

Within the Oregon University System's defined contribution retirement plan, one investment provider offers access to face-to-face financial advice through its network of brokers. Chalmers and Reuter find that younger, less highly educated, and less highly paid employees are more likely to choose this provider. To benchmark the portfolios of broker clients, they use the actual portfolios of self-directed investors and counterfactual portfolios constructed using target-date funds, a popular default investment. Broker clients allocate contributions across a larger number of investments than self-directed investors, and they are less likely to remain fully invested in the default option. However, broker clients' portfolios are significantly riskier than self-directed investors' portfolios, and they under perform both benchmarks. Exploiting across-fund variation in broker compensation, the authors find that broker clients' allocations are higher when broker fees are higher. Survey responses from current plan participants support their identifying assumption that the portfolio choices of broker clients reflect the recommendations of their brokers.

Umit Gurun, University of Texas at Dallas, and Gregor Matvos and Amit Seru, University of Chicago and NBER

Advertising Expensive Mortgages (NBER Working Paper No. 18910)

Gurun, Matvos, and Seru use a unique dataset that combines information on advertising by subprime lenders and mortgages originated by them from 2002 to 2007 to study the relationship between advertising and the nature of mortgages obtained by consumers. They exploit the richness of their data and measure the relative expensiveness of a given mortgage as the excess rate of a mortgage after accounting for a broad set of borrower, contract, and regional characteristics associated with a given mortgage -- less expensive mortgages, all else equal, are better products from the perspective of the consumer. They find a strong positive relationship between the intensity of local advertising and the expensiveness of mortgages extended by lenders within a given region, with the relationship strongest for advertising through newspapers, the most heavily used channel for local advertising of mortgages. This pattern survives even after conditioning for a rich set of borrower, loan and region characteristics and exploiting differences in advertising within a given lender. Advertisers lend to consumers who, all else equal, default less, making it unlikely that these results are driven by unobservable borrower quality. They also exploit variation in mortgage advertising induced by the entry of Craigslist across different regions to demonstrate that the relation between advertising and expensiveness of mortgages is not likely to be spurious. We corroborate that advertising is most effective when targeted at groups that might be less informed about mortgages, such as the poor, the less educated, and minorities. These findings are inconsistent with the “informative view” under which advertising allows consumers to find cheaper products, and instead support the “persuasive view” that advertising in the subprime mortgage market was used to steer consumers into expensive choices.

Santosh Anagol, University of Pennsylvania, and Shawn Cole and Shayak Sarkar, Harvard University

Understanding the Advice of Commissions Motivated Agents: Evidence from the Indian Life Insurance Market

Anagol, Cole, and Sarkar conduct a series of field experiments to evaluate the quality of advice provided by life insurance agents in India. Agents overwhelmingly recommend unsuitable, strictly dominated products, which provide high commissions to the agent. Agents cater to the beliefs of uninformed consumers, even when those beliefs are wrong. The authors test whether regulation or the market can improve advice. A natural experiment requiring disclosure of commissions for a specific product results in agents recommending alternative products with high commissions but no disclosure requirement. Market discipline does generate de-biasing, with agents perceiving greater competition more likely to recommend a suitable product.

John Campbell, Harvard University and NBER; Tarun Ramadorai, University of Oxford; and Benjamin Ranish, Harvard University

Getting Better: Learning to Invest in an Emerging Stock Market

Campbell, Ramadorai, and Ranish report that individual investors in Indian equities hold better performing portfolios as they become more experienced in the equity market. Experienced investors tilt their portfolios profitably towards value stocks and stocks with low turnover, but these tilts do not fully explain their good performance. Experienced investors also tend to have lower turnover and disposition bias. These behaviors, as well as underdiversification, diminish when investors experience poor returns resulting from them, consistent with models of reinforcement learning. Indian stocks held by experienced, well diversified, low-turnover, and low-disposition-bias investors deliver higher average returns, even after controlling for a standard set of stock-level characteristics.

Luigi Guiso, Einaudi Institute for Economics and Finance; Paola Sapienza, Northwestern University and NBER; and Luigi Zingales

Time Varying Risk Aversion

Guiso, Sapienza, and Zingales use a repeated survey of a large sample of clients of an Italian bank to measure possible changes in investors' risk aversion following the 2008 financial crisis. They find that both a qualitative and a quantitative measure of risk aversion increase substantially after the crisis. These changes are correlated with changes in portfolio choices, but do not seem to be correlated with "standard" factors that affect risk aversion, such as wealth, consumption habit, and background risk. This opens the possibility that psychological factors might be driving it. To test whether a scary experience (as the financial crisis) can trigger large increases in risk aversion, the authors conduct a lab experiment. They find that students who watched a scary video have a certainty equivalent that is 27 pecent lower than those who did not. Following a sharp drop in stock prices, a fear model predicts that individuals should sell stocks, while the habit model has the opposite implications-- people should actively buy stock to bring the risky assets to the new optimal level. The authors show that after the drop in stock prices in 2008, individuals rebalanced their portfolio in a way consistent with a fear model.

NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us