Behavioral Finance

November 5
Nicholas C. Barberis of Yale School of Management, Organizer

Ulrike Malmendier, University of California at Berkeley and NBER; Demian Pouzo, University of California at Berkeley; and Victoria Vanasco, Stanford University

A Theory of Experience Effects

Financial crises and other macroeconomic shocks appear to have long-lasting effects on investor behavior and to alter aggregate dynamics in the long run. The theoretical foundations and dynamic implications of such behavior are still debated. Recent evidence suggests that individuals overweight personal experiences of macroeconomic shocks when forming beliefs about risky outcomes and making investment decisions. Malmendier, Pouzo, and Vanasco propose a simple OLG model that formalizes 'experience-based learning.' Risk averse agents can invest in risky and risk-free assets. They form beliefs about the payoff of the risky asset (1) based on data observed during their lifetimes so far and (2) exhibiting recency bias, which are the two key components of experience effects. In equilibrium, prices depend on past dividends, but only those observed by the generations that are alive, and they are more sensitive to more recent dividends. Younger generations react more strongly to recent experiences than older generations. Hence, the young have higher demand for the risky asset than the old in good times, and lower demand in bad times. The model generates predictions for stock-market dynamics and trading volume. First, a recent crisis will increase the average age of agents holding stocks, while booms have the opposite effect. Second, the stronger the disagreement across generations (e.g. after a recent shock), the higher is the trade volume. The researchers provide stylized facts from the Survey of Consumer Finances consistent with the model predictions.

Chen Lian, MIT; Yueran Ma, Harvard University; and Carmen Y. Wang, Harvard University

Low Interest Rates and Risk Taking: Evidence from Individual Investment Decisions

In recent years, many central banks have set benchmark interest rates to historic lows. In this paper, Lian, Ma, and Wang provide evidence that individual investors "reach for yield", that is, have a greater appetite for risk taking in such low interest rate environment. The researchers first document this phenomenon in a simple investment experiment, where investment risks and risk premia are held constant. They find significantly higher allocations to risky assets in the low rate condition, among MTurks as well as HBS MBAs. This reaching for yield behavior is unrelated to institutional frictions, and cannot be easily explained by conventional portfolio choice theory. The researchers then propose and provide evidence for two sets of explanations related to people's preferences and psychology. They also present complementary evidence using historical data on individual investors' portfolio allocations and household investment flows.

Anthony A. DeFusco and Charles G. Nathanson, Northwestern University, and Eric Zwick, University of Chicago and NBER

Speculative Dynamics of Prices and Volume

DeFusco, Nathanson, and Zwick present a dynamic theory of prices and volume in asset bubbles. In their framework, predictable price increases endogenously attract short-term investors more strongly than long-term investors. Short-term investors amplify volume by selling more frequently, and they destabilize prices through positive feedback. This model predicts a lead-lag relationship between volume and prices that the researchers confirm in the 2000-08 U.S. housing bubble. Using data on 50 million home sales from this episode, they document that much of the variation in volume arose from the rise and fall in short-term investment.

Antonio Gargano, University of Melbourne, and Alberto G. Rossi, University of Maryland

Does it Pay to Pay Attention?

Gargano and Rossi employ a novel brokerage account dataset to investigate the relation between individual investor attention and performance. In addition to portfolio holdings and trades, the researchers observe when investors log-in to their trading account, what information they look at, and how much time they spend processing such information. They show that attention is positively related to investment performance – both at the portfolio return level as well as the individual trades level – and provide evidence that the superior performance of high-attention investors arises because they behave as momentum traders that purchase stocks early in the momentum cycle, several months before reversal sets in. The researchers also show that paying attention is particularly profitable when trading stocks with high market capitalization, trading volume, volatility, number of analysts, dispersion of analyst forecasts, and news – indicating that it is for the stocks with high uncertainty, but for which a lot of public information is available, that it pays to pay attention. Finally, the researchers find that account holders with higher invested wealth and higher exposure to small capitalization stocks, growth stocks, momentum stocks, and the overall market, are more attentive; that males pay more attention than females; and that attention is an increasing function of investors' age.

Santosh Anagol, University of Pennsylvania, and Vimal Balasubramaniam and Tarun Ramadorai, University of Oxford

Endowment Effects in the Field: Evidence from India's IPO Lotteries

Anagol, Ramadorai, and Balasubramaniam find that winners of randomly assigned initial public offering (IPO) lottery shares are significantly more likely to hold these shares than lottery losers 1, 6, and even 24 months after the random allocation. This finding persists in samples of highly active investors, suggesting along with additional evidence that this "endowment effect" is not driven by inertia alone. The effect decreases as experience in the IPO market increases, but remains even for very experienced investors. These results provide field evidence derived from the behavior of 1.5 million Indian stock investors consistent with the laboratory literature that documents endowment effects for risky gambles.

Michael Bailey, Facebook; Ruiqing Cao, Harvard University; Theresa Kuchler, New York University; and Johannes Stroebel, New York University and NBER

Social Networks and Housing Markets (NBER Working Paper No. 22258)

Bailey, Cao, Kuchler, and Stroebel document that the recent house price experiences within an individual’s social network affect her perceptions of the attractiveness of property investments, and through this channel have large effects on her housing market activity. The researchers' data combine anonymized social network information from Facebook with housing transaction data and a survey. The researchers first show that in the survey, individuals whose geographically-distant friends experienced larger recent house price increases consider local property a more attractive investment, with bigger effects for individuals who regularly discuss such investments with their friends. Based on these findings, the researchers introduce a new methodology to document large effects of housing market expectations on individual housing investment decisions and aggregate housing market outcomes. This approach exploits plausibly-exogenous variation in the recent house price experiences of individuals' geographically-distant friends as shifters of those individuals' local housing market expectations. Individuals whose friends experienced a 5 percentage points larger house price increase over the previous 24 months (i) are 3.1 percentage points more likely to transition from renting to owning over a two-year period, (ii) buy a 1.7 percent larger house, (iii) pay 3.3 percent more for a given house, and (iv) make a 7% larger downpayment. Similarly, when homeowners' friends experience less positive house price changes, these homeowners are more likely to become renters, and more likely to sell their property at a lower price. The researchers also find that when individuals observe a higher dispersion of house price experiences across their friends, this has a negative effect on their housing investments. Finally, the researchers show that these individual-level responses aggregate up to affect county-level house prices and trading volume. These findings suggest that the house price experiences of geographically-distant friends might provide a valid instrument for local house price growth.

NBER Videos

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

Contact Us