We experimentally disentangle the effect of information feedback from the effect of investment flexibility on the investment behavior of a myopically loss averse investor.Our findings show that varying the information condition alone suffices to induce behavior that is in line with the hypothesis of Myopic Loss Aversion.information;investment

Bellemare, C.

Krause, M.

Kroger, S.

Zhang, C.

English

Research Papers in Economics

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
No. 2004–32 
 
 
 
 
MYOPIC LOSS AVERSION: INFORMATION FEEDBACK VS. 
INVESTMENT FLEXIBILITY 
 
By C. Bellemare, M. Krause, S. Kröger, C. Zhang 
 
April 2004 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ISSN 0924-7815 Myopic Loss Aversion:
Information Feedback vs. Investment Flexibility¤
Charles Bellemareyand Michaela Krausezand Sabine Kr¨ ogerxand Chendi Zhang{
March 10, 2004
Abstract
We experimentally disentangle the effect of information feedback from the effect of in-
vestment ﬂexibility on the investment behavior of a myopically loss averse investor. Our
ﬁndings show that varying the information condition alone sufﬁces to induce behavior
that is in line with the hypothesis of Myopic Loss Aversion.
JEL Codes: D81,C91
Keywords: Myopic loss aversion, information feedback, commitment, investment ﬂexi-
bility.
¤We would like to thank Jan Potters for providing us with instructions and for helpful comments and sugges-
tions. Financial support from the Center for Economic Research (CentER) is gratefully acknowledged.
yDepartment of Econometrics, CentER, Tilburg University, c.bellemare@uvt.nl
zDepartment of Econometrics, CentER, Tilburg University, michaela.krause@uvt.nl
xEconomic Science Laboratory, University of Arizona, s.kroger@econlab.arizona.edu
{Department of Finance, CentER, Tilburg University, c.zhang@uvt.nl
1Introduction
The behavioral hypothesis of myopic loss aversion (MLA), introduced by Bernartzi and
Thaler (1995), predicts that investors with longer evaluation periods ﬁnd risky investments
moreattractive. GneezyandPotters(1997)(hereafterGP)testedthishypothesisinlaboratory
experiments. They compared the investment choices of two groups of subjects with different
evaluation periods: One group of subjects received less information feedback and had less
ﬂexibility in adjusting their investments than a control group. The results of their study sug-
gest that the more frequently returns of investments are evaluated, the lower is the average
level of investments in risky assets. Such an evaluation period effect is in line with the MLA
hypothesis. Haigh and List (2002) replicated the study of GP with professional traders and
found an even stronger effect. Gneezy, Kapteyn and Potters (2003) demonstrated the effect
in a market experiment.
However, all of these experiments exhibit a common design feature: Both the frequency
of information feedback and the level of investment ﬂexibility are manipulated simultane-
ously. Ourquestion ofinterestisto investigatewhich ofthe twomanipulations isresponsible
for the effect of the evaluation period on investment behavior. In this paper, we report an
experimental test that allowed us to disentangle the effect of information feedback from that
of investment ﬂexibility. We ﬁrst replicated the high frequency information / high invest-
ment ﬂexibility treatment (labelled H) and the low frequency information / low investment
ﬂexibility treatment (labelled L) that were used in previous experiments. In addition, we
conducted a high frequency information / low ﬂexibility treatment (labelled M).
IncomparingMandL,theinformationfeedbackisvariedwhiletheinvestmentﬂexibility
is held constant. Whereas in comparing M and H, the investment ﬂexibility is varied while
2the information feedback remains unchanged. We show that the evaluation period effect
previously reported in the literature can be explained by information feedback alone.
1 Test Design and Procedure
We designed the basic setting of our experiment in close resemblance to GP. Participants
were confronted with a sequence of nine independent draws of the same gamble. For each
draw an individual received an endowment of 70 Eurocents, which could be totally or par-
tially invested. In the gamble, there was a probability of 1/3 of winning two and a half times
the amount bet. With probability 2/3 the amount would be lost entirely. Subjects were fully
informed about the objective probabilities of winning and losing, and about the correspond-
ing size of gains and losses. It is important to stress that subjects could not bet any money
accumulated in previous rounds. Hence, the maximum bet in each round was 70 Eurocents,
independently of the outcome of the bet in any of the previous rounds.
First, we replicated the GP treatments H (high frequency information / high ﬂexibility)
and L (low frequency information / low ﬂexibility) in order to provide a basis for compari-
son.
In treatment H the subjects played the gambles one by one. At the beginning of round
one they had to choose how much of their endowment of 70 Eurocents to bet in the lottery.
Then they were informed about the realization of the lottery in round one. Only then they
could decide how much of their new endowment of 70 Eurocents to bet in round two, and
so on. Hence, in this treatment subjects made nine subsequent betting decisions.
In treatment L, on the other hand, subjects played the nine rounds in blocks of three.
At the beginning of round one, subjects had to decide how much of their endowment of 70
3Eurocents to bet in the lotteries of rounds one, two, and three. In addition, these bets were
restricted to be equal. If a subject bet X in round one, she also bet X in rounds two and three.
After subjects decided on their bets, they were informed about the realizations for rounds
one, two, and three at the same time. Subsequently, subjects decided how much to bet in
rounds four, ﬁve, and six, and so on.
In addition to these two treatments, we conducted a third treatment M. In this treatment,
we combined the information condition of treatment H with the ﬂexibility condition of treat-
ment L. That is, while subjects received information about the outcome of the gamble after
each draw, they had to commit to a ﬁxed equal amount of investment for three subsequent
periods in advance in each of the periods one, four, and seven. Hence, relative to treatment
H, varying the evaluation period meant lowering the ﬂexibility while holding the informa-
tion frequency constant. Treatments L and M had the same investment ﬂexibility, but in L
information was obtained at a low frequency while in M information was obtained at a high
frequency.
WeranacomputerizedexperimentwithatotaloftwelvesessionsinSeptember2003. Par-
ticipants were recruited via email from the subject pool of the CentERlab at Tilburg Univer-
sity comprising 500 people at the time of recruitment. The invitation announced a decision-
making experiment that would last no longer than 40 minutes, with a reward that would
depend on their decisions. The experiment was held in the CentER lab, where students were
seated in separated compartments. In total, 135 students participated: 47 in treatment M and
44 in treatments H and L, respectively. The number of subjects per session varied from 4 to
18.
Upon entering the room, instructions written in English were distributed.1 Subjects ex-
1Instructions are in appendix.
4amined the instructions on average for seven minutes, within which also questions were
answered in private.
Treatment H: On the computer screen subjects were asked to enter their bet for the ﬁrst
round. Then, the lottery was conducted by means of a ‘wheel:’ A random number generator
gave out a sequence drawn from the numbers 1, 2, and 3 with each number replacing the
previous until the wheel came to a halt. The subject won in case the last number displayed
was a ‘3.’ After the round, the computer program displayed gains or losses, the proﬁt and
theearnings fromthatroundand subjects recordedtheir earnings ontheir registrationforms.
This procedure was repeated for all nine rounds.
Treatment L: On the computer screen subjects were asked to enter their bet for the sub-
sequent three rounds. Then, three neighboring wheels would run one after the other on the
same computer screen. Next, the computer program displayed gains or losses, the proﬁt and
earnings jointly for the three rounds and subjects recorded their joint results for the previous
three rounds on their registration forms. Note the important difference: In this treatment
subjects recorded one entry per three rounds as opposed to separate entries for each rounds
in the H and M treatments. This procedure was repeated three times, for a total of nine
rounds.
Treatment M: On the computer screen subjects were asked to enter their bet for the sub-
sequent three rounds. Then, the wheel ran one time. Next, the computer program displayed
gains or losses, the proﬁt and earnings from that round and subjects recorded their results.
Thereafter, the wheel ran another time for the second round without subjects entering an-
other bet since the bet had already been decided upon in the ﬁrst round. Again, the com-
puter program displayed the results and subjects had to record them separately from the
5results of the ﬁrst round. The wheel ran a third time and results were again displayed and
recorded separately for the third round. Note that although subjects had to ﬁx their bets for
three rounds in advance, they were forced to experience the gains or losses they had made in
each round separately when recording their results on paper. This procedure was repeated
three times, for a total of nine rounds.
At the end of each treatment, participants calculated their total earnings. The computer
program displayed summary statistics so that we could check the calculations to make sure
that the output of the computer screen matched the amounts entered. Finally, forms were
collected. Sessions for treatments H and M lasted about 30 minutes in total, whereas sessions
for treatment L had a duration of about 20 minutes.
2 Results
In order to analyze the results, we compared average percentages of endowment bet in the
gamble per round across the three treatments. The left-hand side of Table 1 displays these
average percentages of the invested amount for each treatment, while the right-hand side
presents the Mann-Whitney test values for each hypothesis tested. The p-values of each test
are enclosed in brackets.
To begin with, we replicated the test of GP by comparing average investments in the high
frequency information / high ﬂexibility treatment (H) and in the low frequency information
/ low ﬂexibility treatment (L). Like GP, we found average investments in treatment L to be
signiﬁcantly higher than average investments in treatment H for all three blocks.
Thereafter, we tested the null hypothesis that ﬂexibility in adjustment does not affect in-
vestments against the alternative hypothesis that H < M by comparing average investments
6in the high frequency information / high ﬂexibility treatment (H) with average investments
in the high frequency information / low ﬂexibility treatment (M). We could not reject this
null hypothesis in any of the three blocks at 5% signiﬁcance levels.
Finally, we tested the null hypothesis that information feedback does not affect invest-
ments against the alternative hypothesis that M < L by comparing average investments in
the low frequency information / low ﬂexibility treatment (L) with average investments in
the high frequency information / low ﬂexibility treatment (M). We found that subjects with
low investment ﬂexibility but more frequent information on their ﬁnancial situation invested
signiﬁcantly less than subjects who faced the same ﬂexibility but received less information.
This effect was particularly strong in the ﬁrst two blocks, and was less strong but still signif-
icant in the third block at the 6% level. Both sets of tests clearly indicate that the evaluation
period effect found in the literature can entirely be attributed to information feedback rather
than to investment ﬂexibility.
It is interesting to report related evidence in Langer and Weber (2003), who ﬁnd average
investments in their corresponding M treatment to be signiﬁcantly higher than those of their
H treatment. While our results suggest that average investments in our M treatment are not
signiﬁcantly different from those of our H treatment when aggregated over the nine rounds
of play, we ﬁnd in the last three rounds an effect in line with that reported by Langer and
Weber. In particular, average investments in rounds 7 to 9 are slightly higher in treatment M
than in treatment H (p = 0.062). Equally interesting in the Langer and Weber study is their
ﬁnding that average investments in M and L treatments are not statistically different (i.e.
no information feedback effect), which is in sharp contrast to our results. These differences
might be due to the ”multiplicative approach” used by Langer and Weber, where investors
7receive an initial endowment that is transferred from period to period and can be reinvested
together with its returns. In contrast, our design is chosen in consistency with the existing
”additive-based” literature on an evaluation period effect, in which individuals invest a cer-
tain amount out of a constant income ﬂow, and gains and losses in a period do not affect the
endowments in subsequent periods. Although this gives us the advantage of making our
comparisons with the existing literature possible, a more careful comparison of the additive
and multiplicative approaches is an interesting area of future research.
Conclusion
In this paper, we reported the results of an alternative experimental test for the presence
of an evaluation period effect. This test allowed us to disentangle the effect of information
feedback from that of ﬂexibility on the investments in risky assets. We conﬁrm the works
by Gneezy and Potters (1997) and others building on it, and furthermore ﬁnd that experi-
mentally induced myopia in combination with loss aversion remained to affect investment
behavior systematically even when ﬂexibility in adjusting investment was no longer varied.
MLA is driven by information feedback. Hence the latter should be the variable of interest
for researchers and actors in ﬁnancial markets alike.
8References
[1] Benartzi, Shlomo, and Richard Thaler, “Myopic Loss Aversion and the Equity Premium
Puzzle,” Quarterly Journal of Economics, CX (1995), 73-92.
[2] Gneezy, Uri, and Jan Potters, “An Experiment on Risk Taking and Evaluation Periods,”
Quarterly Journal of Economics, CXII, (1997), 632-45.
[3] Gneezy, Uri, Arie Kapteyn, and Jan Potters, “Evaluation Periods and Asset Prices in a
Market Experiment,” The Journal of Finance, LVIII (2003), 821-37.
[4] Haigh, Michael, and John List, “Do Professional Traders Exhibit Myopic Loss Aversion?
An Experimental Analysis,” Working Paper 02-18, University of Maryland.
[5] Langer, Thomas, and Martin Weber, “Does Binding or Feedback Inﬂuence Myopic Loss
Aversion? An Experimental Analysis,” Working Paper, University of Mannheim.
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10

Myopic Loss Aversion: Information Feedback vs. Investment Flexibility

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