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1 January 2014 CFA Institute Journal Review

The Genetics of Investment Biases (Digest Summary)

  1. Louis A. Lemos

The authors use a comprehensive list of investment biases and find that genetic differences account for as much as 45% of the remaining variation across individual investors after controlling for observable individual characteristics. The weight of the data demonstrates consistency with the idea that investment biases are manifestations of innate and evolutionary features of human behavior.

What’s Inside?

The authors’ objective is to evaluate the origins of investment biases as well as the differences across investors. Central to this effort is the consideration of whether investors are genetically endowed with certain predispositions that manifest themselves as investment biases or whether investors are exhibiting biases as a result of nurturing or individual-specific experiences or events. The ability to differentiate between genetic and environmental sources of investment biases has the potential to provide a better understanding of whether education and market incentives might lessen investment biases as well as to help policymakers design public policy.

How Is This Research Useful to Practitioners?

Considering such investment biases as lack of diversification, excessive trading, the disposition effect, performance chasing, and skewness preference, the authors conclude, after they control for observable individual characteristics, that genetic differences explain as much as 45% of the residual variation across individual investors. Particularly interesting is the authors’ reliance on real-world, nonexperimental data to provide direct evidence that persistent investment behaviors are, to a large extent, determined by genetics.

For investors with finance-related work experience, there is a meaningful reduction of the comparative amount of genetic variation, which indicates that experience in finance moderates genetic predispositions to investment biases. General education, however, does not seem to have a similar moderating effect.

Given the potential negative repercussions of investment biases, the authors’ results may affect the design of public policy in the sphere of financial literacy. Specifically, the data suggest that public policy should account for the reality of genetic susceptibilities to investment biases in strategies to mitigate such biases.

Finally, although the focus of the authors’ research is genetics, it is important to point out that the environment also influences investment behaviors. The importance of environment is highlighted by the fact that more than 50% of the variation in investment biases across investors is attributable to individual-specific experiences and events.

How Did the Authors Conduct This Research?

The authors rely on data from the Swedish Twin Registry matched with detailed data on twins’ investment behaviors to facilitate the decomposition of differences across individuals into genetic versus environmental components. The decomposition is based on the underlying fact that identical twins share 100% of their genes, whereas the average proportion of shared genes is only 50% for fraternal twins. Thus, identical twins showing more similarity with respect to the studied investment biases than fraternal twins would provide evidence that these behaviors are influenced to some extent by genetic factors.

To ascertain detailed information on investment behavior, the authors match the registered twins with portfolio and sales transaction data between 1999 and 2007. Investment biases are analyzed using equity investments (i.e., individual stocks as well as equity and mixed mutual funds) with a particular focus on individual stocks. The sample excludes incomplete pairs of twins, with the resulting sample consisting of 15,208 adult twin pairs in which each twin had at least one year of nonmissing equity investment data.

Investment bias measures are developed for diversification, home bias, turnover, disposition effect, performance chasing, and skewness preference. To reduce the dimensionality of some of their analysis, the authors construct an index that summarizes the aforementioned investment behaviors for each investor with holdings of individual stocks.

The model they develop decomposes the cross-sectional variation in investment behaviors into genetic and environmental components. The authors compare correlations between genetically identical investors with correlations between related but nonidentical investors. The rationale is that the comparison provides evidence on the importance of latent genetic factors. The authors provide formal estimation results from decomposing investment biases into genetic and environmental variation and conclude by examining investment biases and behaviors in other domains.

Abstractor’s Viewpoint

Practitioners and academic researchers have long recognized that investment biases are prevalent and persistent and, on balance, negatively influence investment outcomes. The authors focus on the origins of these investment biases and the differences across investors—an important addition to the existing literature that should be of particular interest to practitioners and policymakers. By better understanding how genetic, environmental, and individual experiences or events influence investor behavior, investment professionals and policymakers can formulate such strategies as education and market incentives to moderate the deleterious consequences of investment biases.

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