Examining investor behavioral biases via an experiment, the authors show that investment
style and context influence the behavior of market participants. Investors react to
returns and the volatility of those returns, and losses make investors more reactionary.
Moreover, investor behavior is conditional on both the style of the investor and the
context of the feedback.
How Is This Research Useful to Practitioners?
Using a simulation experiment, the authors show that investors react to short-term
feedback. Both near-term and cumulative poor performance drive investors to spend more time
evaluating their portfolios. The authors find that investors are more likely to tolerate
underperforming investments during periods of good overall portfolio performance.
An investor’s behavior depends on his or her investment style (growth, value,
judgmental, or technical). The authors find significant differences within investment styles
regarding the amount of search effort during uptrending versus downtrending markets. Across
each style classification except value, search and exploration activity varies according to
market conditions (e.g., an uptrending or downtrending market). Value investors generate
significantly fewer transactions. Technical investors exhibit the most reactionary behavior.
The authors find that investors diversify their research efforts largely during times of
uncertainty or negative returns regardless of whether the investors’ approach is
technical or fundamental.
The majority of sales in the study’s data involve stocks with larger-than-average
losses or underperformance, which is contrary to the “disposition effect.” The
authors also observe this effect among value investors, suggesting that this style is not
immune to price patterns, particularly in times of market stress. By shedding further light
on behavioral biases in various market environments, the authors’ results are useful
for investment professionals.
How Did the Authors Conduct This Research?
The authors conduct an experiment with 57 subjects participating in a computer simulation.
All participants have some experience with and an above-average interest in financial
The authors use a 12-month period (May 2010–April 2011) to conduct the three-hour
simulation, with 98 large-cap S&P 500 Index stocks composing the investment universe.
Participants are informed that all stocks in their universe are large cap and liquid, but
the company names are anonymous. Sector classifications are made known to the participants,
who can (but are not required to) evaluate and make changes to their portfolio holdings in
Participants are asked to define their investment style as either growth, value, technical,
or judgmental. Both technical and fundamental indicators are made available to the
participants to drive portfolio decision making. No short selling or leverage is allowed.
Participants are unaware of the performance of other participants.
The authors hypothesize that feedback on performance will trigger reactionary behavior
among the participants when the feedback involves unusually large market moves. Assuming
that the recent volatile environment will reinforce these effects, the authors expect to
observe significant differences with respect to gains and losses.
The authors capture the participants’ behavior via mouse clicks and keyboard
strokes. The results of the study strongly support the authors’ hypothesis of
reactionary behavior in response to feedback, particularly when losses occur. This finding
is consistent across all styles, although the intensity of the behavior varies across
The authors shed additional light on investor behavioral biases. Understanding these biases
is crucial for traders and analysts seeking to gauge current market sentiment as well as for
advisers seeking to explain existing market dynamics to their clients. The investor
behaviors the authors identify are consistent with traits identified in prior market
behavior studies (e.g., anchoring under uncertainty, prospect theory, loss aversion, and
status quo bias). The authors’ evidence is compelling; however, several factors are
worth keeping in mind when evaluating the results.
The data contain two distinct phases: a correction followed by either a choppy rally phase
or a relatively steady rally phase. The nature of the trading environment could have an
impact on style-related behavior. The lack of “avoidance” from value investors
may be because of the stronger overall performance of value that occurred in the
experiment’s timespan rather than any inherent bias with that style.
Participants may have changed their style throughout the experiment in a reactionary
manner. If so, it would be difficult to make conclusions regarding reaction by style. The
strong performance of the S&P 500 over the course of the study (13.9%) could also have
affected the results. A future study in which both market conditions and overall index
performance are reversed would be insightful.
Finally, participants had no prior knowledge of the market environment that preceded the
beginning of the study. Thus, participants’ views were framed only by the real-time
data generated over the course of the experiment, which is unrealistic.