Investors' decisions motivated by their beliefs about stock's future
Washington, August 29 (ANI): A new research has cast doubt on a widely held theory that individual investors' decisions are driven mainly by their feelings toward losses and gains.
In an innovative study, researchers found evidence that individual investors' decisions are primarily motivated by their beliefs about a stock's future.
"The story is not about whether an investor hates losing or loves gains - it's not primarily a story about preferences," said Itzhak Ben-David, co-author of the study and assistant professor of finance at Ohio State University's Fisher College of Business.
"It is a story about information and speculation. The investor has a belief about where a stock is headed and that's what he acts on. Investors act more on their beliefs than their preferences."
Ben-David along with David Hirshleifer of the Paul Merage School of Business at the University of California, Irvine, studied stock transactions from more than 77,000 accounts at a large discount broker from 1990 through 1996 and did a variety of analyses that had never been done before. They examined when investors bought individual stocks, when they sold them, and how much they earned or lost with each sale.
The simplest test was to see what investors do when a stock is trading just slightly higher or lower than the price they paid - in other words a small winner or a small loser.
If investors really did make stock trades based simply on their pleasure in making money and their aversion to realizing losses, a small winner should lead to more sales than a small loser.
But this study found that investors were not clearly more likely to sell when it was a small winner than when it was a small loser.
Another piece of evidence against the theory that investors' decisions are driven by their aversion to realizing losses was the fact that, the more a stock lost value, the more likely investors were to sell it.
"If investors had an aversion to realizing losses, larger losses should reduce the probability they would sell, but we found the opposite - larger losses were associated with a higher probability of selling," Ben-David said.
Interestingly, the stocks that investors sell the least are those that did not have a price change since purchase.
Another clue is the fact that men and frequent traders were more likely than others to sell winning stocks quickly to reap their profits and sell losers quickly to cut their losses.
The researchers also examined when investors were more likely to buy additional shares of a stock that they had previously purchased. They found that the probability of buying additional shares is greater for shares that lost value than it was for shares that gained value.
That shouldn't happen if investors are really acting on emotions rather than beliefs, Ben-David said.
Their results appeared in the August 2012 issue of the journal Review of Financial Studies. (ANI)
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