Abstract
An experimental study was conducted to determine the minimum group size for which the mitigating effect for the hot hand and gambler’s fallacies can be felt. This is quantified by looking if groups are as prone to the hot hand and gambler’s fallacies in making decisions as their individual counter parts. Results suggest that groups maximize their investment returns better than individuals as the former choose to decide on their own more and rely on the experts’ opinions less. Triads are the least biased with the hot hand and gambler’s fallacies and thus are able to make more rational decisions and consequently maximize their investments better than the other treatments.These data allowed us to recognize the benefits of forming investment clubs consisting of three members since their decisions are more likely in line with the profit maximizing strategy in comparison with the decisions made by pairs and individuals.
Highlights
The hot hand fallacy and the gambler’s fallacy are two of the most common behavioral errors in the financial market
In terms of investment strategy, we find that groups make investment decisions differently from individuals
In terms of the behavioral fallacies, we find that both groups and individuals alike are still prone to the hot hand fallacy and gambler’s fallacy, but groups are marginally less prone indicating that there is a mitigation effect by being in a group
Summary
The hot hand fallacy and the gambler’s fallacy are two of the most common behavioral errors in the financial market These biases cause people to misinterpret random sequences believing that some past event can be used to predict future outcomes. People who exhibit the hot hand fallacy expect an increasing trend to continue in the near future This bias is observable when people mostly buy from funds who were successful in the past because they are convinced it would continue to be successful in the latter periods (Sirri & Tufano, 1998). People who exhibit the gambler’s fallacy expect a current trend to ‘break and reverse’ in the future This bias is observable when people buy losing stocks, which are stocks who have recently declined in prices, because they expect a reversal of their losses later. It is unreliable to use past information to predict future prices
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