Implied cost of capital investment strategies - evidence from international stock markets

Investors can generate excess returns by implementing trading strategies based on publicly available equity analyst forecasts. This paper captures the information provided by analysts by the implied cost of capital (ICC), the internal rate of return that equates a firm's share price to the present value of analysts' earnings forecasts. We find that U.S. stocks with a high ICC outperform low ICC stocks on average by 6.0% per year. This spread is significant when controlling the investment returns for their risk exposure as proxied by standard pricing models. Further analysis across the world's largest equity markets validates these results

Overconfident Investors, Predictable Returns, and Excessive Trading

The last several decades have witnessed a shift away from a fully rational paradigm of financial markets toward one in which investor behavior is influenced by psychological biases. Two principal factors have contributed to this evolution: a body of evidence showing how psychological bias affects the behavior of economic actors; and an accumulation of evidence that is hard to reconcile with fully rational models of security market trading volumes and returns. In particular, asset markets exhibit trading volumes that are high, with individuals and asset managers trading aggressively, even when such trading results in high risk and low net returns. Moreover, asset prices display patterns of predictability that are difficult to reconcile with rational-expectations–based theories of price formation. In this paper, we discuss the role of overconfidence as an explanation for these patterns

What can behavioural finance teach us about finance?

Purpose – The paper draws on the key themes raised at a Round Table discussion on behavioural finance attended by academics and practitioners. The paper provides a background to the key aims of behavioural finance research and the development of the discipline over time. The purpose of this paper is to indicate some future research issues on behavioural finance that emanate from the financial crisis and highlight areas of mutual benefit to both behavioural finance academics and the finance industry so as to encourage a creative cross-fertilisation. Design/methodology/approach – The paper draws on a Round Table discussion on behavioural finance that was organized by the Behavioural Finance Working Group, the Centre for the Study of Financial Innovation and Financial Services Knowledge Transfer Network. Findings – The paper highlights numerous benefits that behavioural finance research can contribute to the financial industry, but at the same time there is an evident discrepancy between the academic and the professional world when it comes to utilising behavioural finance research. Practical implications – The paper highlights several areas where behavioural finance can contribute significant benefits to a wide array of aspects of the finance industry. Social implications – The paper seeks to inform behavioural finance issues so as to encourage collaboration between the academic world and finance practitioners. In so doing, the paper aims to encourage a greater awareness of individual decision-making frames and heuristics and how industry can apply these concepts to improve the allocation of finance products to society. Originality/value – The paper brings together a wide array of finance professionals and academics to encourage greater collaboration and mutual respect of each others interest in and uses for behavioural finance.Behavioural economics, Finance

Double T hen Nothing: W hy Individual Stock Investments Disappoint

A bstract Behavioral researchers argue that while individuals often rely on heuristics or rules of thumb that reduce the complexity involved in predicting values, such heuristics can lead to severe and systematic errors. I test this argument in an investment context by focusing on a simple heuristic whereby momentum traders are attracted to buying stocks that have recently doubled in price in anticipation of further gains. I show that such a strategy can lead to predictable disappointment for these investors and severe underperformance relative to the market (-28% over a four-year period), whereas investors who avoid relying on this simple heuristic are likely to perform as expected, on average similar to the overall market. The reversals in addition to past performance per se, as uncovered in other studies. JEL Codes: G11, G12, G1