Sensation Seeking, Overconfidence, and Trading Activity

This study analyzes the role that two psychological attributes%u2014sensation seeking and overconfidence%u2014play in the tendency of investors to trade stocks. Equity trading data are combined with data from an investor%u2019s tax filings, driving record, and psychological profile. We use the data to construct measures of overconfidence and sensation seeking tendencies. Controlling for a host of variables, including wealth, income, age, number of stocks owned, marital status, and occupation, we find that overconfident investors and those investors most prone to sensation seeking trade more frequently.

The Disposition Effect and Momentum

Prior experimental and empirical research documents that many investors have a lower propensity to sell those stocks on which they have a capital loss. This behavioral phenomenon, known as 'the disposition effect,' has implications for equilibrium prices. We investigate the temporal pattern of stock prices in an equilibrium that aggregates the demand functions of both rational and disposition investors. The disposition effect creates a spread between a stock's fundamental value -- the stock price that would exist in the absence of a disposition effect -- and its market price. Even when a stock's fundamental value follows a random walk, and thus is unpredictable, its equilibrium price will tend to underreact to information. Spread convergence, arising from the random evolution of fundamental values, generates predictable equilibrium prices. This convergence implies that stocks with large past price runups and stocks on which most investors experienced capital gains have higher expected returns that those that have experienced large declines and capital losses. The profitability of a momentum strategy, which makes use of this spread, depends on the path of past stock prices. Crosssectional empirical tests of the model find that stocks with large aggregate unrealized capital gains tend to have higher expected returns than stocks with large aggregate unrealized capital losses and that this capital gains 'overhang' appears to be the key variable that generates the profitability of a momentum strategy. When this capital gains variable is used as a regressor along with past returns and volume to predict future returns, the momentum effect disappears.

Debt Policy, Corporate Taxes, and Discount Rates

This paper studies the valuation of assets with debt tax shields when debt policy is a general time-dependent function of the asset's unlevered cash flows, value, and history. In a continuous-time setting, it shows that the value of a project's debt tax shield satisfies a partial differential equation, which simplifies to an easily solved ordinary differential equation for most plausible debt policies. A large class of cases exhibits closed-form solutions for the value of a levered asset, the value of its tax shield, and the appropriate tax-adjusted cost of capital for discounting unlevered cash flows.

Tax-Loss Trading and Wash Sales

An analysis of trades in the Finnish stock market around the turn of the year shows that Finnish investors tend to realize losses more than gains towards the end of December. They also buy back the same stocks they recently sold, with a repurchase rate that depends on the size of the capital loss and how close the sale is to the end of December. The resulting net buying pressure from these 'wash sale' repurchases is greater for stocks with small market capitalizations and has a calendar pattern that is similar to that of stock returns.

What Do We Really Know About the Cross-Sectional Relation Between Past and Expected Returns?

Multihorizon temporal relationships between stock returns are complex due to confounding sources of return premia, microstructure effects, and changes in the relationship over various horizons. We find the relation to be further complicated by the sign and consistency of the past return that also varies, somewhat sensibly, with the season and the tax environment. Accounting for these additional effects using a parsimonious technical trading rule generates surprisingly large abnormal returns, despite controlling for microstructure effects, transaction costs, and data-snooping biases. The documented variation in profits across stock characteristics, season, and tax environment appear inconsistent with existing theory, but may point to future explanations for the relation between past and expected returns.

Interpersonal Effects in Consumption: Evidence from the Automobile Purchases of Neighbors

This study analyzes the automobile purchase behavior of all residents of two Finnish provinces over several years. It finds that a consumer's purchases are strongly influenced by the purchases of his neighbors, particularly purchases in the recent past and by neighbors who are geographically most proximate. There is little evidence that emotional biases, like envy or an urge to conform, lie behind the interpersonal influence in automobile consumption. The most reasonable alternative explanation for these findings is some form of information sharing among neighbors.

Agnostic fundamental analysis works

To assess stock market informational efficiency with minimal data snooping, we take the view of a statistician with little knowledge of finance. The statistician uses techniques such as least squares to estimate peer-implied fair values from the market values of replicating portfolios with the same accounting statements as the company being valued. Divergence of a company's peer-implied value estimate from its market value represents mispricing, motivating a convergence trade that earns risk-adjusted returns of up to 10% per year and is economically significant for both large and small cap firms. The rate of convergence decays to zero over the subsequent 34 months

The information content of institutional trades on the London Stock Exchange

We construct a unique data set that includes all reported institutional block trades on the London Stock Exchange and analyze the market reaction to buy and sell trades. We find that the type of investors behind the trade and the combination of the trade's size and the trader's resulting level of ownership are the major determinants of the information effects and the asymmetry between price impacts of buy and sell trades. In particular, large trades undertaken by fund managers, the most active investors in our sample, have strong information content, while, for the remaining trades, we report limited support for the information and the price impact asymmetry hypotheses. These results hold even after accounting for trade complexity and volatility effects in the regressions