Behavioral Finance Literature Research Articles

Predicting investors’ intention to invest in the stock market during COVID-19: can we use an extended theory of planned behavior?

PurposeThis study aims to explain investors’ intention to invest in the stock market amid the COVID-19 pandemic by expanding the Theory of Planned Behavior (TPB).Design/methodology/approachThis study adopts a quantitative approach, and a questionnaire-based survey was conducted to collect responses from existing and potential individual investors. To test the relationships between variables, structural equation modeling was used.FindingsThe findings indicated that investors’ attitude and perceived behavioral control had a significant influence on investment intentions. Further, perceived knowledge of COVID-19 improved the ability to predict the intention to invest. Moreover, psychological risk significantly moderated the association between subjective norms related to investors and their attitudes. Overall, the tested model was able to better account for the intention of investors in stock market investments.Research limitations/implicationsIn this study, only the investor reactions in the context of an emerging market were evaluated, and future studies could focus on different market contexts and perform comparative studies. Financial markets could be considered as a mechanism that has a direct impact on the wealth distribution of society, and the key findings of this study could be used to promote investment in emerging markets, where participation is comparatively low.Originality/valueThe TPB was expanded by incorporating investors’ perceived knowledge of COVID-19 and psychological risk dimensions, which were then tested in an emerging market context to fill the knowledge gap identified in the contemporary behavioral finance literature.

A Literature Review of Credit Ratings

The behavioural finance literature focuses on the impact of investor sentiment on the underlying value of individual stocks. Credit ratings can be viewed as a link between borrowers and issuers that reduce information asymmetry in the financial system through an independent view of creditworthiness. The purpose of this study was to determine the variables related to credit ratings. This research is a literature study, which uses 21 articles as study material. The results of this study indicate the variables related to credit ratings, both influencing and being influenced. This study did not find credit ratings used as a moderating variable, which can be used as research material in the future.

CEO POWER AND RISK-TAKING: INTERMEDIATE ROLE OF PERSONALITY TRAITS

In our paper we discuss how different personal characteristics of a CEO, being affected by CEO power, may in turn affect personal risk-taking. Agency theory states that managers have non-changing risk preferences and are either risk-averse or risk-neutral. In contrast to that, there may be cases, when managers are risk-seekers and power of executives is positively related to excessive risk-taking. Additionally, agency theory assumes that CEOs are homogenous in power use and ignores difference of CEOs in term of personality traits as well as its impact on corporate decisions. Therefore, our aim is to focus specifically on factors that connect CEO power with CEO risk-taking and to analyze possible effects of that relationship on firm. Based on both psychological and managerial studies, we conclude that, on the one hand, CEO’s power can affect CEO’s personal traits by producing [in the case of overconfidence or hubris] or by enhancing them [in case of narcissism]. On the other hand, CEO’s personal traits affect CEO’s risk-taking. It can be either by changing the perception of risk or because of behavior patterns inherent to those traits. Finally, we hypothesize that CEO power can affect CEO personal risk-taking through personality traits. By examining relationship between CEO power and CEO risk-taking based on individual-level determinants, our paper adds to the behavioral corporate finance and corporate governance literature.

Paralyzed by shock: the portfolio formation behavior of peer-to-business lending investors

We examine investor behavior on a leading peer-to-business lending platform and identify an investment mistake that we refer to as default shock bias. First, we find that investors stop investing in new loans and cease diversifying their portfolio after experiencing a loan default. The default shock significantly worsens the risk–return profile of investors’ loan portfolios. The defaults investors experience are often not beyond what would have been expected from the information that was provided by the platform ex ante. Second, investment experience on the platform is related to better investment decisions in general, but it does not reduce the default shock bias. These findings have important implications not only for the behavioral finance literature but also more generally for new forms of Internet-based finance.

Long-lasting heuristics principles for efficient investment decisions

PurposeBehavioral solutions to our cognitive biases have long been studied in the literature. However, there is still ample evidence of behavioral biases in decision-making, with only limited improvement in the medium/long term even when debiasing methods are applied. The purpose of this paper is to describe how financial investors could benefit from a proactive management of emotions combined with a set of learning and decision-making heuristics to make more efficient investments in the long run.Design/methodology/approachFirst, the authors offer a classification of the appropriate quantitative and qualitative methodologies to use in different ecological environments. Then, the authors offer a list of detailed heuristics to be implemented as behavioral principles intended to induce more long-lasting changes than the original rules offered by the adaptive toolbox literature. Finally, the authors provide guidelines on how to embed artificial intelligence and cognitive diversity within the investment decision architecture.FindingsImprovements in decision skills involve changes that rarely succeed through a single event but through a succession of steps that must be habitualized. This paper argues that implementing a more conscious set of personal and group principles is necessary for long-lasting changes and provides guidelines on how to minimize systematic errors with adaptive heuristics. To maximize their positive effects, the principles outlined in this paper should be embedded in an architecture that fosters cognitively diverse teams. Moreover, when using artificial intelligence, the authors advise to maximize the interpretability/accuracy ratio in building decision support systems.Originality/valueThe paper proposes a theoretical reflection on the field of behavioral research and decision-making in finance, where the chief goal is to offer practical advices to investors. The literature on debiasing cognitive biases is limited to the detection and correction of immediate effects. The authors go beyond the traditional three building blocks developed by the behavioral finance literature (search rules, stopping rules and decision rules) and aim at helping investors who are interested in finding long-term solutions to their cognitive biases.

Investor sentiment, R&D spending and firm performance

Prior literature indicates that the stock market is not simply a sideshow but also a factor that impacts corporate operations and decisions. This study examines the effect of a noise factor in the stock market, investor sentiment, on the relationship between the firm’s R&D spending and firm performance. Using a sample of publicly traded firms in the Chinese A-share market between 2006 and 2019, the study demonstrates that R&D spending generally enhances (reduces) firm performance during optimism (pessimism) periods. Concerning the channels through which investor sentiment impacts the R&D spending-firm performance relationship, market-timing effects indicate that firms that time equity issuance during optimism periods experience a positive R&D spending-firm performance relationship, whereas firms that initiate equity repurchase during pessimism periods have a negative R&D spending-firm performance relationship. For catering effects, when firms cater to short-horizon investors, R&D spending reduces firm performance. The results contribute to R&D and behavioural finance literature.

Money as a symbol in the relationship between financial advisors and their clients: a dyadic study

PurposeThe paper aims to examine whether financial advisors can understand the symbols and meaning that investors associate with money and whether such ability plays any role in enhancing the advisor-investor relationship in terms of satisfaction, level of trust, referral propensity and loyalty.Design/methodology/approach The authors used a dyadic research design. A total of 186 dyads of financial advisors and their clients took part in the study and completed two parallel self-administered questionnaires.Findings The authors found that financial advisors often can detect the emotional associations that their clients attribute to money. Such ability can enhance their relationship with investors.Research limitations/implicationsThe main limitation of this study is its exploratory nature and the convenience sampling technique that was adopted. Therefore, researchers are encouraged to test the main findings further.Practical implicationsThe results have implications for the development of ad-hoc psychological training to enhance the relationship between financial advisors and investors. Understanding the symbolic meanings and the emotions that clients associate with money may be a prerequisite for a financial services company to succeed and be competitive in the sector.Originality/valueDespite acknowledging that money is not a neutral object but is layered with symbolic meanings and emotional associations, the behavioral finance literature has so far neglected to study these implications from either a theoretical or a practical point of view. This paper aims to fill this gap by investigating the symbolic value of money in the financial services industry.

A new behavioral finance mean variance framework

PurposeThe author proposes an update to the mean variance (MV) framework that replaces a constant risk aversion parameter using a dynamic risk aversion indicator. The contribution to the literature is made through making the static risk aversion parameter operational using an indicator of market sentiment. Results suggest that Sharpe ratios improve when the author replaces the traditional risk aversion parameter with a dynamic sentiment indicator from the behavioral finance literature when allocating between a risky portfolio and a risk-free asset. However, results are mixed when using the behavioral framework to allocate between two risky assets.Design/methodology/approachThe author includes a dynamic risk aversion parameter in the mean variance framework and back test using the traditional and updated behavioral mean variance (BMV) framework to see which framework leads to better performance.FindingsThe author finds that the behavioral framework provides superior performance when allocating between a risky and risk-free asset; however, it under performs when allocating between risky assets.Research limitations/implicationsThe research is based on back testing; therefore, it cannot be concluded that this strategy will perform well in real-time circumstances.Practical implicationsPortfolio managers may use this strategy to optimize the allocation between a risky portfolio and a risk-free asset.Social implicationsAn improved allocation between risk-free and risky assets that could lead to less leverage in the market.Originality/valueThe study is the first to use such a sentiment indicator in the traditional MV framework and show the math.

Covid-19 e os impactos nas políticas de financiamento e investimento

Abstract Purpose: To analyze how the Covid-19 has impacted the financing, capital structure, and investment policies of Brazilian companies from a behavioral finance perspective. Originality/value: The study focused on the behavioral finance literature, Prospect Theory, Big Five Theory, and Pecking Order Theory, in order to substantiate and explain the consequences of the emotions implicit in corporate decisions and their impacts on organizations during the Covid-19 crisis. Design/methodology/approach: A questionnaire was used, containing 26 questions spread over three sections: 1. investment, financing, and capital structure decisions made in the first half of 2020; 2. personality dimensions of the respondents; and 3. sociodemographic profiles of the respondents. A total of 120 responses was obtained and the ordinary least squares econometric model was applied to identify the influence of biases on corporate decisions. Findings: The results found showed that managers’ decisions have been influenced by heuristics and biases, especially decisions on starting new projects and raising funds, as it was found that overconfidence bias has prevailed in investment and financing decisions. The study also demonstrated that the decline in sales and lost profitability of Brazilian companies due to Covid-19 have led to bold behavior by managers, as they have sought to reverse the impacts of the pandemic.

Biases in Managerial Decision Making: Overconfidence, Status Quo, Anchoring, Hindsight, Availability

Decision-making processes occur with the interaction of some cognitive and psychological variables. Neoclassical theories deal with rational reactions in these processes. However, in an environment where there is no information or where there is uncertainty instead of risk, decisions cannot be made rationally as the mind indicates. In this direction, firm managers have to make many decisions under uncertainty. For this reason, managers resort to various simple and useful shortcuts called bias for different reasons. In this study, it was aimed to reveal the effects of behavioral biases on management decisions. In this context, five biases in the behavioral finance literature, namely overconfidence, status quo, anchoring, hindsight and availability, were evaluated with theoretical and empirical studies and their effects on managerial decisions were discussed. It was seen that raising awareness of these biases in terms of managers provides benefits such as realistic evaluation of themselves, giving more realistic weights to events when making decisions, reaching rational judgments more easily and being open to innovations. In addition, this awareness, when combined with the emotional competencies of managers, helps them make successful decisions.

Investment Behavior and Trade Returns of Individual Investor: Mediating Role if Financial Literacy

The main objective of current study was to analyze the impact of representativeness and anchoring on the trade returns of individual investors with the mediating role of financial literacy. In this connection hypotheses were developed on the basis of behavioral finance literature. The data was collected on 5-point likert scale questionnaires which were adopted from various authors. The collected data was checked for reliability and correlation analysis and regression models were run. On the basis of results obtained from analysis the four hypotheses which were developed have been accepted. It was concluded that representativeness and anchoring has significant positive impact while the financial literacy has mediating impact on the trade returns of investors. It is recommended that more the financial literacy less risk of behavioral biases impact on investment thus investors should gain financial literacy for taking rational investment decision and good trade returns.

Stock markets' reaction to COVID-19: the joint impact of uncertainty avoidance culture and government response–evidence from emerging countries

PurposeThe authors examine whether the uncertainty avoidance culture and the stringency of government response play a role in shaping the stock market's response to coronavirus disease 2019 (COVID-19). The authors find that investors' response to the pandemic will not only depend on their instinct of uncertainty aversion but also on their expectation about the effectiveness of the government measures. The uncertainty avoidance culture amplifies the irrational actions of investors. However, harsh government responses will weaken this effect. Harsh government responses also send a negative signal to the market about the extent of the pandemic and the economic damage caused by anti-COVID measures. Governments need to be balanced in imposing anti-COVID measurements to preserve market confidence.Design/methodology/approachIn this article, the authors investigate whether the stock market volatility of emerging countries is simultaneously driven by two factors: the uncertainty-aversion culture of investors in a country and the stringency of the government's response to the pandemic. The authors conduct an empirical study on a sample of 20 emerging countries during the period from January 2020 to March 2021.FindingsThe authors find that the national-level uncertainty aversion amplifies the irrational actions of investors during the period of crisis. However, harsh government responses will weaken this effect. The authors’ findings show evidence that investors' response to the pandemic will not only depend on their instinct of uncertainty aversion but also on their expectation about the effectiveness of the government measures. Although harsh government responses can stabilize the investors' sentiment in countries with high levels of uncertainty aversion, they also send a negative signal to the market about the extent of the pandemic as well as the economic damage caused by anti-COVID measures.Originality/valueFirst, the study’s results complement evidence from existing studies on the effect of uncertainty avoidance culture in determining stock market responses to COVID-19. Second, an important difference from previous studies, this paper adds to the behavioral finance literature by showing that investors' investment decisions in the face of economic uncertainty are not driven solely by their cultural values but also by their expectation about the effectiveness of the government policy. During a crisis, when the market has neither rational information nor adequate experience to forecast the future, the government must play an important role in stabilizing investors' sentiment and reactions.

The stock market as a casino: Associations between stock market trading frequency and problem gambling.

Background and aimsPersonal investors decrease their stock market investment returns by trading frequently, which the behavioral finance literature has primarily explained via investors' overconfidence and low levels of financial literacy. This study investigates whether problem gambling can help account for frequent trading in a sample of active gambler/investors, as suggestive of frequent trading being in part driven by a behavioral addiction to gambling-like activities.MethodsA retrospective cross-sectional study of 795 US-based participants, who reported both being active gamblers and holding stock market investments. Recollected stock trading activity (typical portfolio size, purchases and sales of stocks) was compared with scores on the Problem Gambling Severity Index, a financial literacy scale, and a measure of overconfidence.ResultsSelf-reported relative stock portfolio turnover was positively associated with problem gambling scores. This association was robust to controls for financial literacy, overconfidence, and demographics, and occurred equally among investors of all self-reported portfolio sizes.Discussion and conclusionsThis study provides support for the hypothesis that behavioral addiction to gambling-like activities is associated with frequent stock market trading. New investment products that increase the ease of trading may therefore be detrimental to some investors.

Accounting for investor sentiment in news and disclosures

PurposeThis study aims to develop two sentiment indices sourced from news stories and corporate disclosures of the firms in the National Stock Exchange NIFTY 50 Index by extracting sentiment polarity. Subsequently, the two indices would be compared for the predictive accuracy of the stock market and stock returns during the post-digitization period 2011–2018. Based on the findings this paper suggests various options for financial strategy.Design/methodology/approachThe news- and disclosure-based sentiment indices are developed using sentiment polarity extracted from qualitative content from news and corporate disclosures, respectively, using qualitative analysis tool “N-Vivo.” The indices developed are compared for stock market predictability using quantitative regression techniques. Thus, the study is conducted using both qualitative data and tools and quantitative techniques.FindingsThis study shows that the investor is more magnetized to news than towards corporate disclosures though disclosures contain both qualitative as well as quantitative information on the fundamentals of a firm. This study is extended to sectoral indices, and the results show that specific sectoral news impacts sectoral indices intensely over market news. It is found that the market discounts information in disclosures prior to its release. As disclosures in quarterly statements are delayed information input, firms can use voluntary disclosures to reduce the communication gap with investors by using the internet. Managers would do so only when the stock price is undervalued and tend to ignore the market and the shareholder in other cases. Otherwise, disclosure sentiment attracts only long horizon traders.Practical implicationsFinance managers need to improve disclosure dependence on investors by innovative disclosure methodologies irrespective of the ruling market price. In this context, future studies on investor sentiment would be interesting as they need to capture man–machine interactions reflected in market sentiment showing the interplay of human biases with machine-driven decisions. The findings would be useful in developing the financial strategy for protecting firm value.Originality/valueThis study is unique in providing a comparative analysis of sentiment extracted from news and corporate disclosures for explaining the stock market direction and stock returns and contributes to the behavioral finance literature.

Examining investors' sentiments, behavioral biases and investment decisions during COVID-19 in the emerging stock market: a case of Pakistan stock market

PurposeThis study investigates the impact of the COVID-19 pandemic on investors' sentiments, behavioral biases and investment decisions in the Pakistan Stock Exchange (PSX).Design/methodology/approachThe authors have assessed investors' behaviors and sentiments and the stock market overreaction during COVID-19 using a questionnaire and collected data from 401 investors trading in the PSX.FindingsResults of structural equation modeling revealed that the COVID-19 pandemic affected investors' behaviors, investment decisions and trade volume. It created feelings of fear and uncertainty among market participants. Evidence suggests that behavioral heuristics and biases, including representative heuristic, anchoring heuristic, overconfidence bias and disposition effect, negatively influenced investors' decisions at the PSX.Research limitations/implicationsThis study will contribute to behavioral finance literature in the context of developing countries as it has revealed the impact of COVID-19 on the emerging stock market, and its results are generalizable to other emerging stock markets.Practical implicationsThe findings of this study will help academicians, researchers and policymakers of developing countries. Academicians can formulate new behavioral models that can depict the solutions of dealing with an uncertain situation like COVID-19. Policymakers like the Securities Exchange Commission and the PSX can formulate crisis management strategies based on behavioral finance concepts to cope with situations like COVID-19 in the future and help lessen investors' losses in the stock markets. The role of the Securities Exchange Commission is crucial as it regulates the financial markets. It can arrange workshops to educate investors to manage their decisions during crisis time and focus on the best use of irrational and rational decision-making at the same time using Lo (2004) adaptive market hypothesis.Originality/valueThe novelty of the paper is that the authors have introduced overconfidence and disposition effect as mediators that create a connection between representative and anchoring heuristics and investment decisions using primary data collected from investors (institutional and retail) to demonstrate the presence of psychological biases during COVID-19, and it has been done for the first time according to authors' knowledge. It is a contribution and addition to the behavioral finance literature in the context of developing countries' stock markets and their efficiency.

In name only: Information spillovers among Chinese firms with similar stock names during earnings announcements

We examine whether investors' attention on salient firm characteristics affects information spillovers during corporate earnings announcements. For market participants in China, the stock name is a salient feature of listed companies. We find that the market reaction of non-announcing firms to earnings reports of announcing firms is greater across firms with similar stock names. The incremental information spillovers among similarly named stocks are stronger for larger announcing firms and on days with fewer earnings announcements. The incremental information spillovers between similarly named stocks do not fully reverse in the post-announcement period, consistent with persistent investor behavior predicted by the salience theory. There are also significant return comovements among similarly named stocks. Our findings suggest that investors with limited attention are likely to focus on salient stock names and overestimate the economic connections between similarly name stocks. Our study extends the behavioral finance literature by showing how investors' attention on salient firm features can bias their reaction to unrelated peer disclosures.

An investigation on behavioral biases in ship investments of small-sized shipping companies

Purpose This study aims to explain the facts about behavioral biases that cannot be explained by rational patterns in ship investments of small-size shipping companies. Design/methodology/approach A qualitative approach was adopted in this study. The systematic approach of Wolcott (1994) and the action flows proposed by Miles and Huberman (1994) were taken into consideration. Findings Factors affecting ship investments are classified as ship finance, market timing, ship specifications and profile and business models of ship investors. In addition, behavioral biases that stand out under each theme are explained in the light of behavioral finance literature. Originality/value The originality of this study rests on the lack of studies on behavioral aspects of ship investments.

Asset-light strategies and stock market reactions to COVID-19’s pandemic announcement: The case of hospitality firms

This research note investigates the stock market reactions of international hospitality firms to COVID-19’s pandemic announcement by the World Health Organization. In line with the behavioral finance literature, the findings indicate that, in the short term, investors overestimated the risks underlying asset-heavy firms because of information uncertainty. Firms pursuing an asset-light (AL) strategy are associated to significantly less negative cumulative abnormal returns in the 4 days following the announcement, especially firms following an AL strategy that reduces significantly the operating leverage. However, this difference vanishes after 5 trading days, meaning that investors revised their expectations. This research note suggests that the cost structure of AL firms matters in reducing information uncertainty and sheds light on the consequences of the COVID-19 crisis on the hospitality industry. It also provides useful information to board members, financial analysts, and companies’ top managers when evaluating whether and how to pursue an AL strategy, and the potential consequences of it.

Algorithmic Models of Investor Behavior

We propose a heuristic approach to modeling investor behavior by simulating combinations of simpler systematic investment strategies associated with well-known behavioral biases—in functional forms motivated by an extensive review of the behavioral finance literature—using parameters calibrated from historical data. We compute the investment performance of these heuristics individually and in pairwise combinations using both simulated and historical asset-class returns. The mean-reversion or momentum nature of a heuristic can often explain its effect on performance, depending on whether asset returns are consistent with such dynamics. These algorithms show that seemingly irrational investor behavior may, in fact, have been shaped by evolutionary forces and can be effective in certain environments and maladaptive in others.

Foreign-language effect and professionals’ judgments on fair value measurement: Evidence from Germany and the United Kingdom

International Financial Reporting Standards (IFRS) have been developed in an attempt to minimize the differences in accounting practices across countries. These standards are developed in English and translated into other local languages. However, if professionals attach different meanings in interpreting key accounting concepts based on the language used, then comparability and consistency of their judgments will be compromised. We contribute to the behavioral finance literature by examining whether experienced professionals attach consistent or different connotative meanings to one of the key IFRS concepts, namely, ‘fair value’. Our findings show a consistent pattern of differences in professionals’ judgments on ‘fair values’ in English and its German translation. Awareness of a foreign-language effect will help professionals, firms, and standard setters to develop communication and language strategies and policies.