Speculation as a Learned Behavior? Adaptive Rationality Among New Investors and the Evolution of a Nascent Market

Abstract

This inductive study examines the extent to which small, newly recruited investors learn to mimic the trading behaviors of experienced institutional investors in an emerging capital market characterized by policies that incentivize speculative trading in IPO shares. Theoretically, I explore how small, inexperienced investors learn to trade shares more effectively and how the ordering and attributes of listing firms facilitate or impede this learning process. Empirically, I model rates of speculative IPO trading for investors based on portfolio value, registration type (individual vs. company), and previous experience in the Kenyan IPO market and chart the relative rates of speculative trading between investor groups over the course of successive IPOs. Analysis of individual data for 1.4 million domestic investors across six consecutive IPOs in Kenya’s nascent stock market from 2006 to 2008 suggests that low portfolio value individual investors are initially much less likely than institutional investors to act on short-term profit opportunities, but small increases in experience levels quickly produce rates of speculative trading by small investors that matches those of the largest investors. However, this learning process can be disrupted by differences in share price trajectories between IPOs as well as characteristics of listing firms, as smaller investors are more likely to formulate unreasonable expectations of share price gains in IPOs of high status firms and in IPOs that follow offers with abnormally high returns. Results are discussed as a theory of nascent market evolution, where I argue that the investing public’s learned orientation to short-term share ownership forces a reconsideration of state-level regulatory policies as well as firm level decisions about when to list in an emerging market.