Individual and institutional herding and the impact on stock returns: Evidence from Taiwan stock market

Using high frequency intraday data, this paper investigates the herding behavior of institutional and individual investors in the Taiwan stock market. The study finds evidence of herding by both investors but a stronger herding tendency among institutional than among individual investors. Institutional investors herd more on firms with small capitalizations and lower turnovers and they follow positive feedback strategies. The portfolios that institutional investors herd buy outperform those they sell by an average of 1.009% during the 20 days after intense trading episodes. By contrast, individual investors herd more on firms with small sizes and higher turnovers, and they crowd to buy (sell) stocks with negative (positive) past returns. The portfolios that individual investors herd buy underperform those they sell by an average of − 0.829% during the following 20 days. Moreover, these return differences of both investors are more pronounced under a market with higher pressure and among small stocks. These findings suggest that the herding of institutional investors speeds up the price-adjustment process and is more likely to be driven by correlated private information, while individual herding is most likely to be driven by behavior and emotions.     

Individual investors’ information use,subjective expectations,and portfolio risk and return

What information do individual investors use when making their financial decisions and how is it related to their stock market expectations, their confidence in these expectations, and the risk and return of their stock portfolios? I study these questions by combining survey data on the information usage among individual investors in Sweden with detailed registry data on their stock portfolios. I find that investors use filtered financial information (e.g. information packaged by a professional intermediary) more frequently than they use unfiltered financial information (e.g. information from annual reports and financial statements). Investors who frequently use filtered financial information are, however, more confident in their stock market expectations and take larger risks in their stock portfolios. Investors that instead use unfiltered financial information take lower portfolio risks and obtain higher portfolio returns. The findings in this paper thus suggest that investors can improve their financial decisions by using more unfiltered financial information rather than filtered financial information when they make their financial decisions.     

DO FOREIGN INVESTORS PRICE FOREIGN EXCHANGE RISK DIFFERENTLY?

We test whether foreign investors price foreign exchange risk differently from local investors. Drawing from the closed‐end country fund literature, we argue that both differential access to information by foreign versus local investors and different sources of exchange risk that investors face (economic or translation exposure) will lead to different pricing of the exchange risk associated with American Depositary Receipt (ADR) investments. We apply a two‐step method to country portfolios of ADRs of Australia, France, Japan, and the United Kingdom traded on the New York Stock Exchange. Our results show that foreign investors generally price exchange risk differently from local investors, and that the source and magnitude of differences in exchange risk pricing vary significantly across countries. Although significant differences in pricing exchange risk between foreign and local investors are observed for Australia, France, and Japan, no such pricing difference is noticed for the United Kingdom. Furthermore, the pricing differences observed for Australian and French ADRs are mainly attributed to the exchange risk of underlying share returns (economic exposure), whereas the pricing differences for Japanese ADRs are mainly attributed to the exchange risk associated with currency translation (translation exposure). We offer some explanations for our findings.     

Experimental Evidence on Portfolio Size and Diversification: Human Biases in Naïve Security Selection and Portfolio Construction

We conduct an experiment in which individuals select securities to reproduce the well‐known relationship between portfolio risk and the number of securities. The standard result occurs on average but not for most individuals, many of whom effectively de‐diversify as they add seemingly random securities. Moreover, only slightly better results are achieved using a random number generator. This finding challenges the belief that only a small number of securities are required for diversification and shows that it is applicable only to a large sample. The implications are important given that many individual investors hold very few stocks in their portfolios.     

DO INSTITUTIONAL INVESTORS IN THE UK ADOPT A DUAL STRATEGY FOR MANAGING FOREIGN EXCHANGE RISK?

In recent years, the gradual increase in international portfolio diversification within the UK institutional investment community has led to a growing need to manage foreign exchange (FX) risk. This paper reports on the findings of a postal questionnaire survey relating to FX risk management practices in UK institutional investment organisations. The findings demonstrate an increasing awareness of the FX risk management problem and indicate that UK investment institutions actively manage FX risk within their investment portfolios. The paper also focuses on the interesting question of whether UK institutional investors manage their own portfolio's FX risk, simultaneously concerning themselves with their investee companies’ FX risk management practices. Overall, the findings indicate that institutional investors adopt adual strategyfor managing FX risk; not only managing their own FX risk, but also requiring that their investee companies manage FX risk. There is also evidence to suggest that the institutional investors require their investee companies to disclose information relating to their FX risk management policies.     

Confidence and Investors' Reliance on Disciplined Trading Strategies

Researchers and practitioners in accounting and finance often investigate or advocate particular disciplined trading strategies, but little work investigates the determinants of individual investors' trading‐strategy reliance. We report two experiments, which provide evidence that the dual‐source model of overconfidence (Sniezek and Buckley [1991]) predicts the circumstances in which investors are more likely to rely on disciplined trading strategies. Our results indicate that reliance is more likely when investors trade portfolios of securities rather than trading on a case‐by‐case basis, particularly when investors have received feedback that their previous (unaided) trading decisions have been unprofitable. These results are driven by the number of shares that investors transact rather than by investors' directional agreement with the recommendations of the trading strategy, suggesting that the effects of a portfolio approach and trading experience occur by mitigating investors' overconfidence. The effects violate an aspect of economic rationality because our experiments ensure that investors in all conditions trade the same set of securities based on the same set of information.     

Twin Picks: Disentangling the Determinants of Risk‐Taking in Household Portfolios

This paper investigates risk‐taking in the liquid portfolios held by a large panel of Swedish twins. We document that the portfolio share invested in risky assets is an increasing and concave function of financial wealth, leading to different risk sensitivities across investors. Human capital, which we estimate directly from individual labor income, also affects risk‐taking positively, while internal habit and expenditure commitments tend to reduce it. Our microfindings lend strong support to decreasing relative risk aversion and habit formation preferences. Furthermore, heterogeneous risk sensitivities across investors help reconcile individual preferences with representative‐agent models.     

How Much Is Investor Autonomy Worth?

There is a worldwide trend towards defined contribution savings plans, where investors are often able to select their own portfolios. How much is this freedom of choice worth? We present retirement investors with information about the distribution of outcomes they could expect to obtain from the portfolios they picked for themselves, and the same information for the median portfolio selected by their peers. A majority of our survey participants actually prefer the median portfolio to the one they picked for themselves. We investigate various explanations for these findings and offer some evidence that the results are partly attributable to the fact that investors do not have well‐defined preferences.     

Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off

This paper proposes a portfolio choice model in which investors are subject to liquidation risk and (endogenously) face higher costs in the event of joint liquidation (as was observed during the crisis of 2008 to 2009). The risk of joint liquidation creates an incentive for investors to choose heterogeneous portfolios and to rationally forgo diversification benefits. Joint liquidation risk is also reflected in asset prices, resulting in (1) assets with high idiosyncratic risk having low expected returns, and (2) assets that display high correlation with the portfolios of (liquidation‐prone) investors having high expected returns.     

Mean-variance versus utility maximization revisited: The case of constant relative risk aversion

We examine if mean-variance (M-V) is a good proxy for portfolios based on the Constant Relative Risk Aversion (CRRA) utility function. M-V portfolios are considered good proxies for portfolios from several utility functions which is why they are routinely used in the portfolio theory literature as the benchmark. Our results clearly show this is not the case. Low risk CRRA portfolios are in many cases very different to M-V portfolios, especially with respect to downside risk. If a risk-free asset is available, in many cases, no M-V portfolio is an adequate proxy for CRRA portfolios. The implications of our findings are that: i) M-V portfolios are a poor proxy for investors with CRRA preferences, ii) CRRA portfolios are more suited to investors who care about downside risk than M-V portfolios, and iii) the efficacy of M-V to proxy for utility maximization should be examined more thoroughly.     

Does Academic Research Destroy Stock Return Predictability?

We study the out‐of‐sample and post‐publication return predictability of 97 variables shown to predict cross‐sectional stock returns. Portfolio returns are 26% lower out‐of‐sample and 58% lower post‐publication. The out‐of‐sample decline is an upper bound estimate of data mining effects. We estimate a 32% (58%–26%) lower return from publication‐informed trading. Post‐publication declines are greater for predictors with higher in‐sample returns, and returns are higher for portfolios concentrated in stocks with high idiosyncratic risk and low liquidity. Predictor portfolios exhibit post‐publication increases in correlations with other published‐predictor portfolios. Our findings suggest that investors learn about mispricing from academic publications.     

Market timing for the individual investor: Using the predictability of long-horizon stock returns to enhance portfolio performance

Recent research indicates that dividend yield and earnings-price ratio can partially predict long-horizon stock returns. We examine whether individual investors can successfully construct timing portfolios based on either of these variables or a measure of the expected market risk premium. The out-of-sample tests in this study require that investors rely only on information that was available at the time of the market-timing decision. Timing portfolios based on the market risk premium show the strongest ability to time the market. We present an economic rationale for the results that is consistent with efficient markets.     

An Exploration of the Conditional Timing Performance of UK Unit Trusts

Abstract:  We examine the conditional market timing performance of UK unit trusts between January 1988 and December 2002. We find no evidence of superior conditional market timing performance by UK unit trusts either across different portfolios of trusts or by individual trusts. We also find that benchmark investing is significant for UK unit trusts and trusts have high numerical risk aversion to deviations from the benchmark. Our findings suggest that UK trusts act like benchmark investors.     

Algorithmic portfolio choice: lessons from panel survey data

Automated asset management offerings algorithmically assign risky portfolios to individual investors based on investor characteristics such as age, net income, or self-assessment of risk aversion. Using new German household panel data, we investigate the key household characteristics that drive private asset allocation decisions. This information allows us to assess which set of variables should be included in algorithmic portfolio advice. Using heavily cross-validated classification trees, we find that a combination of household balance sheet variables—describing the ability to take risks (e.g., net wealth)—and household personal characteristics—describing the willingness to take risks (e.g., risk aversion)—best explain the cross-sectional variation in household portfolio choice. Our empirical evidence is in line with models of portfolio choice under decreasing relative risk aversion and fixed investment costs. The results suggest the utility of a more holistic modeling of household characteristics. Including background risks in the form of household leverage not only makes investment sense, but is also the new regulatory reality under MIFID II rules. Robo-advisors are strongly advised to act accordingly.     

Investor sentiment and economic forces

Economic theory suggests that pervasive factors should be priced in the cross-section of stock returns. However, our evidence shows that portfolios with higher risk exposure do not earn higher returns. More importantly, our evidence shows a striking two-regime pattern for all 10 macro-related factors: high-risk portfolios earn significantly higher returns than low-risk portfolios following low-sentiment periods, whereas the exact opposite occurs following high-sentiment periods. These findings are consistent with a setting in which market-wide sentiment is combined with short-sale impediments and sentiment-driven investors undermine the traditional risk-return tradeoff, especially during high-sentiment periods.     

Ambiguity and asset pricing: An empirical investigation for an emerging market

This study explores the impact of ambiguity on returns of both individual stocks and stock portfolios in an emerging market setting. First, an ambiguity index is derived and then the sensitivity of stock returns to ambiguity is analyzed while controlling for the other risk factors commonly cited in the literature. Results show that stocks with a high (low) sensitivity to ambiguity generate higher (lower) excess returns. These results are intuitive in the sense that investors seem to ask for lower returns from those stocks that serve as a natural hedge against ambiguity. Our findings are also in line with the earlier studies that provide similar evidence from the US stock markets.     

REIT Institutional Ownership Dynamics and the Financial Crisis

Collectively, institutional investors hold large ownership stakes in REITs. The traditional view is that institutions are both long-term and passive investors. The financial crisis beginning in 2007 provides an opportunity to analyze the investment choices of institutional investors before, during, and after the crisis. Our results indicate that institutional ownership increased prior to the financial crisis, declined significantly during the period of market stress, but rebounded after. These results hold for four institutional investor subtypes: mutual funds/investment advisors, bank trusts, insurance companies, and other institutions, with mutual funds/investment advisors and bank trusts most clearly exhibiting this pattern. We also find evidence that institutions actively manage their REIT portfolios, displaying a “flight to quality” after the market downturn by reducing beta and individual risk exposure, and by increasing ownership in larger REITs.     

Is Bitcoin a better portfolio diversifier than gold? A copula and sectoral analysis for China

This paper aims to compare Bitcoin with gold in the diversification of Chinese portfolios using daily data over the 2010–2020 period. We propose a new development of copula-based joint distribution function of returns to simulate the Value-at-Risk and expected shortfall of portfolios including Bitcoin (or gold) and those without it. The stochastic dominance method is also used to compare the return distributions of the three types of portfolios. Empirical results show that gold is a better portfolio diversifier than Bitcoin as it helps better reduce the risk of portfolios. On the other hand, Bitcoin better increases the return but also increases the risk. The stochastic dominance results further show that portfolios diversified by gold dominate those diversified by Bitcoin. Based on these findings, we conclude that in China, gold is a better portfolio diversifier than Bitcoin for risk-averse investors. However, for risk-seeking investors, Bitcoin can be a better choice. This result is found to be robust to the time, frequency and currency effects.     

Do Alternative Real Estate Investment Vehicles Add Value to REITs? Evidence from German Open-ended Property Funds

Besides the more commonly used REITs, German investors can also invest in a lesser-known real estate vehicle, Open-ended Property Funds. OPFs are considered a compromise between listed and direct real estate investments. OPF fund managers generally provide daily (perfect) liquidity. However, if liquidity falls below 5%, share redemptions in these funds can be temporarily suspended for a period of up to two years. During this time, investors will only be able to sell shares on the secondary market (exchange), and are thus subject to significant liquidity risk. The objective of this paper is to analyze whether OPFs add value to investor portfolios above that provided by REITs. We show that OPFs have a diversification advantage over REITs in low-risk portfolios, despite their larger potential liquidity risk. REIT liquidity is comparable to that of ordinary common stock, but OPFs exhibit an average initial discount to funds’ NAV of about 6% when share redemptions are temporarily suspended. However, in the long-run, this potential redemption suspension does not negatively influence OPF performance (in case OPFs reopen again). This makes OPFs an attractive investment alternative to REITs for investors who have a high level of risk aversion and a long-term investment horizon, such as endowments, insurance companies, and pension funds.     

机构投资者与个人投资者过度自信行为比较研究

本文首先基于我国A股市场机构股票持有数据,构建了不同的投资组合来区分机构投资者与个人投资者的投资行为。然后运用Granger因果检验与SUR估计,探讨了我国证券市场机构投资者与个人投资者是否具有过度自信行为,结果表明无论是机构投资者还是个人投资者在不同市场状态下都存在交易过多的过度自信认知偏差。并且我国证券市场上个人投资者与机构投资者的过度自信程度在不同的市场状态下并无明显差异。最后提出了相关政策建议。