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1 July 2015 CFA Institute Journal Review

Weather-Induced Mood, Institutional Investors, and Stock Returns (Digest Summary)

  1. Rich Wiggins, CFA

Investors may view stocks as mispriced for a variety of reasons, and being in a bad mood may cause individuals to examine information with greater scrutiny. The authors look into the effect that weather has on the trading patterns of institutional investors and how that effect influences the stock market. They conclude that cloudier days increase the perception that individual stocks and the DJIA are overpriced, thereby increasing the inclination for institutions to sell.

What’s Inside?

Building on previous findings from psychological studies about the effect of sunshine on mood, the researchers explore how mood affects professional investors’ opinions of the stock market. The authors examine the effect of cloud cover as a mood-priming device and trace that to the impact on institutional trading behavior at the aggregate and individual stock levels. They conclude that sunny skies put sophisticated investors more in a mood to buy, whereas cloudy conditions tend to discourage stock purchases. Weather has an impact on investors’ moods, which affects their trading patterns and, ultimately, the direction and magnitude of returns on certain days.

How Is This Research Useful to Practitioners?

Mood can have an intertemporal effect on decision making and induce the comovement of securities. The results of this study indicate that investors’ perceptions of mispricing, trading decisions, and risk tolerance can change from day to day for reasons that are not presumed by classical models of investor behavior. Behavioral finance and the cognitive biases of investors have received a great deal of attention recently, and misattributing mood induced by weather as information would be another case of human nature affecting the markets.

The authors’ hypothesis that investor behavior is subconsciously influenced by factors affecting mood that are unrelated to market information or firm fundamentals is important and has many practical ramifications. Weather-based proxies of mood affect institutional investor beliefs, trading behavior, and ultimately, stock prices. Given the heightened importance accorded risk management in the post-crisis environment, it is important to recognize the presence of mood-congruent biases in risk-based decisions.

Most researchers who have searched for a link between seasonal affective disorder and attitudes have looked at the general population. This study is the first to directly test for the weather effect in institutional investor trading behavior.

How Did the Authors Conduct This Research?

Evaluating the weather-related behavior of institutional investors is more challenging than evaluating retail investors because relevant data are hard to find. The authors test their conjecture using financial data from multiple sources that are matched to ZIP code–level weather station data. By linking responses to a survey of investors from Yale University’s Investor Behavior Project (by Nobel Prize–winning economist Robert Shiller) with institutional stock trade data from Ancerno Ltd. and historical weather data from the National Oceanic and Atmospheric Administration, the authors are able to simultaneously observe the locations of investors, approximate their behavior, and precisely measure weather conditions.

Their approach is able to account for differences in weather across regions of a country and the seasons, but a large number of assumptions had to be made. The authors could not observe the daily holdings of institutional investors, so they relied on quarterly SEC Form 13F filings to identify a snapshot of institutional investments. An investor might actively trade in a stock but hold no position at the SEC filing dates. The average daily sky cloud cover was calculated using only hourly values from 6:00 a.m. to 12:00 p.m. because it was presumed that this period is the one when investors would most likely observe outdoor weather conditions. It is also possible that respondents take more than one day to fill out the survey or use information that has already been collected over time to determine their responses. There was little theory to help with the estimation window, so the authors evaluated periods ranging from one day to four weeks.

Abstractor’s Viewpoint

The results of the study are surprising given that institutional investors are well regarded for their financial sophistication. Other studies have shown that ordinary retail investors are susceptible to psychological biases in their investment decisions, but one would not expect supposedly “smart money” institutional investors to be subject to the same cognitive biases as everyone else investing in the markets. That said, the findings are consistent with evidence in the psychology literature. The results show that these documented mood effects influence stock prices—particularly among stocks with higher arbitrage costs—but the observed impact does not persist for long periods of time.

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