Memory, Perception, and Asset Prices
Sunday, Jan. 5, 2020 8:00 AM - 10:00 AM (PDT)
- Chair: Cary Frydman, University of Southern California
AbstractHow does memory shape individuals' financial decisions? We find experimental evidence of a self-serving memory bias, which distorts beliefs and drives investment choices. Subjects who previously invested in a risky stock are more likely to remember positive investment outcomes and less likely to remember negative outcomes. In contrast, subjects who did not invest but merely observed the investment outcomes do not have this memory bias. Importantly, subjects do not adjust their behavior to account for the fallibility of their memory. After investing, they form overly optimistic beliefs and re-invest in the stock even when doing so reduces their expected return. The memory bias we document is relevant for understanding how people form expectations from experiences in financial markets and, more generally, for understanding household financial decision-making.
Biased Assessment of Comovement
AbstractI document a systematic bias in the assessment of comovement: individuals assess a moderate relationship between two variables regardless of the actual strength of the relationship between them. In a survey of finance professionals, participant-assessed betas of different financial and macroeconomic variables with the stock market exhibit compression towards moderate values. In an empirical setting, electricity futures exhibit moderate comovement with gas futures despite persistent heterogeneity in the comovement of gas and electricity in the spot market. Trading against this bias generates annualized excess returns of 7.3 percent and a annualized Sharpe ratio of 1.14. Finally, professional forecasters also exhibit this bias, leading to predictable errors in macroeconomic forecasts.
- G1 - General Financial Markets