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Investor Psychology

Paper Session

Saturday, Jan. 5, 2019 2:30 PM - 4:30 PM

Hilton Atlanta, Grand Ballroom A
Hosted By: American Finance Association
  • Chair: Cary Frydman, University of Southern California

Doing Less With More

Rawley Heimer
Boston College
Alex Imas
Carnegie Mellon University


The ability to borrow (use leverage to trade assets) increases an individual’s opportunity set. According to standard theories of decision-making under uncertainty, this makes individuals better off, because they can borrow to enter new positions without having to liquidate advantageous holdings. In contrast, we argue that leverage interacts with existing behavioral biases to impair financial decision-making. To identify leverage's effect, we exploit regulation that restricts the amount of leverage available to U.S. retail traders of foreign exchange. These traders make fewer trading mistakes – they have better market timing and less of a disposition effect – following the leverage constraint. We corroborate these findings in a controlled, incentivized laboratory experiment. Leverage leads to significantly lower earnings, and these lower earnings are caused by a greater tendency to hold losses. A dynamic model of cumulative prospect theory and realization utility explains these results. Together, our findings suggest that paternalistic regulations that constrain financial choices can improve welfare.

"Outlier Blindness": Efficient Coding Generates an Inability to Represent Extreme Values

Elise Payzan-LeNestour
University of New South Wales
Michael Woodford
Columbia University


How do people perceive outliers? Building on a well-established theory
from neuroscience, we conjecture that people are inherently hampered in
the way they perceive outliers because the human brain has been designed
to devote neural activity to representing the most probable values at the
expense of the improbable ones. We find support for this conjecture in a
series of controlled laboratory experiments.

Monetary Policy and Reaching for Income

Kent Daniel
Columbia University
Lorenzo Garlappi
University of British Columbia
Kairong Xiao
Columbia University


This paper studies the impact of monetary policy on investors' portfolio choice and asset prices. Using data on mutual fund flows and individual trading records, we find that low-interest-rate monetary policy increases investors' demand for high-dividend stocks and drives up their asset prices. The increase in demand is more pronounced among investors who live off dividend income for consumption. To explain these empirical findings, we develop a portfolio choice model in which investors have quasi-hyperbolic time preferences and use dividend income as a commitment device to curb their tendency to over-consume in the short-run. When accommodative monetary police lowers interest rates, it reduces the income stream from bonds and induces investors who want to keep a desired level of consumption to ``reach for income'' by tilting their portfolio towards high-dividend stocks. Our finding suggests that low-interest-rate monetary policy may lead to under-diversification of investors' portfolios and may cause redistributive effects across firms that differ in their dividend policy.
Justin Birru
Ohio State University
Andrew Lo
Massachusetts Institute of Technology
Yueran Ma
Harvard University
JEL Classifications
  • G1 - General Financial Markets