Baker and Ricciardi, Investor Behavior

Investor Behavior: The Psychology of Financial Planning and Investing, edited by H. Kent Baker and Victor Ricciardi (Wiley, 2014), goes beyond the standard literature on behavioral finance. In over 600 pages and 30 chapters the contributors write about everything from demographic and socioeconomic factors of investors to financial therapy, from money and happiness to the surprising real world of traders’ psychology.

The book is divided into six parts: foundations of investor behavior, personal finance issues, financial planning concepts, investor psychology, trading and investing psychology and strategies, and special investment topics.

For this post I’m going to focus on a single paper, “Human Psychology and Market Seasonality,” by Lisa A. Kramer, associate professor of finance at the University of Toronto. It is a survey of research findings (incorporate them into your trading at your own peril) on links between seasonal factors and market performance. For instance, “the cloudier the weather is in the city of the exchange (relative to seasonal weather norms), the more negative is the impact on returns for that exchange.” (p. 367)

Following up on several studies showing that depressed people are more averse to risk, researchers tested hypotheses linking seasonality of moods and seasonality in markets. A 2003 study hypothesized that “if diminished length of day in the autumn causes investors’ risk aversion to increase, those investors become less inclined to hold risky stocks. … Following winter solstice, as the length of day starts to increase, investors would begin recovering from their depression and would become more willing to hold risky assets, at which time stock prices and returns would be positively influenced.” (p. 368) A later study, “after controlling for standard stock return regularities,” found “significant evidence of seasonal variation in returns consistent with seasonally varying investor risk aversion that arises due to seasonal depression. The patterns are more prominent in stock markets at extreme latitudes, such as Sweden, where the seasonal fluctuations in daylight are more extreme. Furthermore, both the seasonal patterns and the seasons are six months out of sync in southern hemisphere markets such as Australia.” (pp. 369-70)

Yet another study looked at analyst earnings forecasts and found that analyst optimism “decreases during the months when seasonal depression is commonly observed.” (p. 371) Even IPO prices seem to come under the spell of seasonality. Of more than 4,000 issues of which just under half occurred in the fall and winter, there was “significantly more IPO underpricing in the fall and winter seasons compared to the rest of the year.” (p. 371)

Even daylight saving time changes seem to affect the markets. A study looking at stock index returns from Canada, the U.S., Germany, and the U.K. found “significantly negative returns on the trading day that immediately follows the time change, both in the spring and in the fall. This finding is consistent with the possibility that investors become more averse to financial risk when their routine sleep habits are disturbed by the daylight saving time change.” (p. 373) Weekend sleep disruption may also account for the generally negative Monday results.

And not only does weekend sleep disruption have a negative effect on Monday market returns. It seems that “stock returns are lower on the Monday immediately following high attendance at comedy movies” since “individuals in a good mood are more likely to be cautious.” (p. 376) This finding would seem to contradict the association between negative mood states and negative daily stock returns, but I assume some fine tuning and psychological wizardry could reconcile these findings.

I’m being very unfair to the breadth of Investor Behavior by writing about only one article, and a controversial one at that. (Perhaps unfairness correlates with depth of snow and persistence of storms.) The book contains a wealth of information supported by academic studies that should be of interest to the intellectually curious investor.