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April 10, 2006



This is what I don't like about behavioural economics; it just goes from "hey here's a result from experimental psychology" to "hey here's a stock market anomaly" with very little in the way of theory joining the two:

[Investors who have lost money on a stock might continue holding it, in the hope of recouping theit losses]

How would this lead to momentum in stock returns?


D2 - I share your scepticism in many cases; all my equity money is in tracker funds.
My hypothesis - that's all - here is that a reluctance to sell losing stocks keeps their prices high relative to their "fundamentals". If there are limits on how much short selling "rational" investors can do, such shares will be over priced. But gradually, prices might drift down, say because investors lose hope of recouping their losses.
There's plenty of evidence to suggest that there is often momentum in share prices (see link above): the question is why? In this particular case, I'm not sure about the risk-based explanations.


[If there are limits on how much short selling "rational" investors can do, such shares will be over priced.]

Surely not in any normal microstructure (this is my field in as much as I have a field), though?

If there is no short selling allowed at all, the peak was 100, the last print was 75 and fundamental value is 50, then everything you say could be true, but the next print will still be 50, because it will take place between an informed trader on the bid and a holder selling for liquidity reasons on the offer. The guys holding on to their stock don't trade, and so they don't take part in the price formation process.

In order to get the "slow drift down" result, you have to postulate a continuum of reservation prices in the public order book, and then it becomes clear that this assumption is doing all the work and the behavioural stuff is a fifth wheel.

In other words, there is momentum in share prices because there is a (actual or implied) set of reservation prices which is equivalent to a limit order book, and a rational large purchaser (or set thereof) will establish his position by taking out the limit orders one by one.

I just think that finance is perhaps the very worst possible place for behavioural economics to try and establish a foothold, because most of the behavioural models as they are now specified rely on some implicit assumption of price formation through a Walrasian tatonnement of supply and demand, whereas financial market prices are one of the areas where the specific microstructure makes a huge difference. It doesn't help that behavioural finance is chock full of people who are refugees from mainstream economics trying to escape all the maths, while microstructure theory is full of mathematicians trying to escape all the economics.


Bottom line is Wayne Rooney is f**king thick sh*t scouser knuckle dragging chav who is paid too much just for kicking a piece of leather/plastic around a field for 90 minutes. The fact has even been given a book deal speaks volumes for our trash culture society where "celebrity chavs" are put on a pedestal.

Gavin Allinson

It is sad that Rooney has to look outside himself so much for happiness and excitement. he needs some good advisors, otherwise he is another Gazza waiting to happen.

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