Driving the Market
When Do Investors Freak Out?: Machine Learning Predictions of Panic Selling
Daniel Elkind et al.
MIT Working Paper, August 2021
Abstract:
Despite standard investment advice to the contrary, individuals often engage in panic selling, liquidating significant portions of their risky assets in response to large losses. Using a novel dataset of 653,455 individual brokerage accounts belonging to 298,556 households, we document the frequency, timing, and duration of panic sales, which we define as a decline of 90% of a household account’s equity assets over the course of one month, of which 50% or more is due to trades. We find that a disproportionate number of households make panic sales when there are sharp market downturns, a phenomenon we call ‘freaking out’. We show that panic selling and freakouts are predictable and fundamentally different from other well-known behavioral patterns such as overtrading or the disposition effect. Investors who are male, or above the age of 45, or married, or have more dependents, or who self-identify as having excellent investment experience or knowledge tend to freak out with greater frequency. We use a five-layer neural network model to predict freakout events one month in advance, given recent market conditions and an investor’s demographic attributes and financial history, which exhibited true negative and positive accuracy rates of 81.5% and 69.5%, respectively, in an out-of-sample test set. We measure the opportunity cost of panic sales and find that, while freaking out does protect investors during a crisis, such investors often wait too long to reinvest, causing them to miss out on significant profits when markets rebound.
The big bang: Stock market capitalization in the long run
Dmitry Kuvshinov & Kaspar Zimmermann
Journal of Financial Economics, forthcoming
Abstract:
We study trends and drivers of long-run stock market growth in 17 advanced economies. Between 1870 and the 1980s, stock market capitalization grew in line with GDP. But over subsequent decades, an unprecedented expansion saw market cap to GDP ratios triple and remain persistently high. While most historical stock market growth was driven by issuances, this recent expansion was fueled by rising equity prices. We show that the key driver of this structural break was a profit shift towards listed firms, with listed firm profit shares in both GDP and capital income doubling to reach their highest levels in 146 years.
Why Have Interest Rates Fallen Far Below the Return on Capital?
Magali Marx, Benoît Mojon & François Velde
Journal of Monetary Economics, forthcoming
Abstract:
Interest rates have been falling since the mid-1980s while the return on capital has not. In a calibrated OLG model with recursive preferences encompassing many of the “usual suspects” cited in the debate on secular stagnation, we find that lower trend growth accounts for the trends in the US and the euro area real rates. The increase in the risk premia reflects two sets of forces. Bonds have become better hedges for stocks, notably in the euro area, and risk aversion has increased. In our model, changes in labor share, longevity and inequality had negligible effects on interest rates.
Music Sentiment and Stock Returns Around the World
Alex Edmans et al.
Journal of Financial Economics, forthcoming
Abstract:
This paper introduces a real-time, continuous measure of national sentiment that is language-free and thus comparable globally: the positivity of songs that individuals choose to listen to. This is a direct measure of mood that does not pre-specify certain mood-affecting events nor assume the extent of their impact on investors. We validate our music-based sentiment measure by correlating it with mood swings induced by seasonal factors, weather conditions, and COVID-related restrictions. We find that music sentiment is positively correlated with same-week equity market returns and negatively correlated with next-week returns, consistent with sentiment-induced temporary mispricing. Results also hold under a daily analysis and are stronger when trading restrictions limit arbitrage. Music sentiment also predicts increases in net mutual fund flows, and absolute sentiment precedes a rise in stock market volatility. It is negatively associated with government bond returns, consistent with a flight to safety.
Warren Buffett Anomaly
Mingshan Zhang
Finance Research Letters, forthcoming
Abstract:
Warren Buffett is a long-term investor, but is required by law to disclose his trades every quarter. While the market reacts to the disclosure of his trades, the reaction is incomplete. From 1980 to 2018, it has been possible to achieve investment results similar to Buffett's own simply by mimicking his trades disclosed. Buffett's long-term strategy is surmised to exploit the underreaction to the public disclosures of his stock holding, which is further attributed to the overconfidence bias from some market participants. We found that when Buffett buys stocks, financial analysts tend to downgrade the recommendation and institutions tend to sell at those times. This behavior by analysts and fund managers comports well with the view that financial professionals over-estimate their stock picking abilities or the precision of their private information and, as a consequence, underreact to public information in making their decisions.
Listening in on investors’ thoughts and conversations
Hailiang Chen & Byoung-Hyoun Hwang
Journal of Financial Economics, forthcoming
Abstract:
A large literature in neuroscience and social psychology shows that humans are wired to be meticulous about how they are perceived by others. In this paper, we propose that impression management considerations can also end up guiding the content that investors transmit via word of mouth and inadvertently lead to the propagation of noise. We analyze server log data from one of the largest investment-related websites in the United States. Consistent with our proposition, we find that investors more frequently share articles that are more suitable for impression management despite such articles less accurately predicting returns. Additional analyses suggest that high levels of sharing can lead to overpricing.
Hedge Fund Flows and Performance Streaks: How Investors Weigh Information
Guillermo Baquero & Marno Verbeek
Management Science, forthcoming
Abstract:
Cash flows to hedge funds are highly sensitive to performance streaks, a streak being defined as subsequent quarters during which a fund performs above or below a benchmark, even after controlling for a wide range of common performance measures. At the same time, streaks have limited predictive power regarding future fund performance. This suggests investors weigh information suboptimally, and their decisions are driven too strongly by a belief in continuation of good performance, consistent with the “hot hand fallacy.” The hedge funds that investors choose to invest in do not perform significantly better than those they divest from. These findings are consistent with overreaction to certain types of information and do not support the notion that sophisticated investors have superior information or superior information processing abilities.
Geographic Clustering of Institutional Investors
Donghyun Kim, Qinghai Wang & Xiaoqiong Wang
Journal of Financial Economics, forthcoming
Abstract:
The U.S. money management industry is geographically concentrated and diverges from the geographic clustering of public firms. We find that firms located in states with strong institutional investor presence have high valuation. These firms invest more and their investments are less dependent on internal cash flow. They are more likely to issue equity than debt for financing needs, and local institutions hold more of the newly issued equity. The results show the geographic dislocation between institutional investors and firms contributes to financial market frictions, and a strong institutional investor presence alleviates the funding friction of local firms, leading to high valuation.
Social Proximity to Capital: Implications for Investors and Firms
Theresa Kuchler et al.
Review of Financial Studies, forthcoming
Abstract:
We show that institutional investors are more likely to invest in firms from regions to which they have stronger social ties but find no evidence that these investments earn a differential return. Firms in regions with stronger social ties to locations with many institutional investors have higher valuations and liquidity. These effects are largest for small firms with little analyst coverage, suggesting that the investors' behavior is explained by their increased awareness of firms in socially proximate locations. Our results highlight that the social structure of regions affects firms' access to capital and contributes to geographic differences in economic outcomes.
The Democratization of Investment Research and the Informativeness of Retail Investor Trading
Michael Farrell et al.
Journal of Financial Economics, forthcoming
Abstract:
We study the effects of social media on the informativeness of retail trading. Our identification strategy exploits the editorial delay between report submission and publication on Seeking Alpha, a popular crowdsourced investment research platform. We find the ability of retail order imbalances to predict the cross-section of stock returns and cash-flow news increases sharply in the intraday post-publication window relative to the pre-publication window. The findings are robust to controlling for report tone and stronger for reports authored by more capable contributors. The evidence suggests that recent technology-enabled innovations in how individuals share information help retail investors become better informed.
Dark Pool Trading and Information Acquisition
Jonathan Brogaard & Jing Pan
Review of Financial Studies, forthcoming
Abstract:
Theory suggests that dark pools may facilitate or discourage information acquisition. We find that more dark pool trading leads to greater information acquisition. We measure information acquisition using stock price dynamics around earnings announcements. To overcome endogeneity concerns, we exploit a large exogenous decrease to dark pool trading that results from the implementation of the Security and Exchange Commission’s (SEC’s) Tick Size Pilot Program. The results cannot be explained by lit venue liquidity, algorithmic trading, or informational efficiency. A battery of additional tests, such as documenting a shift in SEC EDGAR searches, supports the information acquisition interpretation.