Hostname: page-component-cd9895bd7-fscjk Total loading time: 0 Render date: 2025-01-05T13:33:59.724Z Has data issue: false hasContentIssue false
  • English
  • Français

Institutional Investors, Past Performance, and Dynamic Loss Aversion

Published online by Cambridge University Press:  01 February 2009

Paul G. J. O’Connell  and
Melvyn Teo
Paul G. J. O’Connell
Affiliation:
FDO Partners LLC, 5 Revere St., Cambridge, MA 02138. [email protected]
Melvyn Teo
Affiliation:
Singapore Management University, 50 Stamford Rd., Singapore 178899, Singapore. [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

Using a proprietary database of currency trades, this paper explores the effects of trading gains and losses on risk-taking among large institutional investors. We find that institutional investors, unlike individuals, are not prone to the disposition effect. Instead, institutions aggressively reduce risk following losses and mildly increase risk following gains. This asymmetry is more pronounced later in the calendar year and among older and more experienced funds. We show that such performance dependence is consistent with dynamic loss aversion (Barberis, Huang, and Santos (2001)) and overconfidence. In addition, prior institutional gains and losses have palpable implications for future prices.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 44 , Issue 1 , February 2009 , pp. 155 - 188
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Badrinath, S. G., and Wahal, S.. “Momentum Trading by Institutions.” Journal of Finance, 57 (2002), 2449–2478.CrossRefGoogle Scholar
Barber, B., and Odean, T.. “Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” Journal of Finance, 55 (2000), 773–806.CrossRefGoogle Scholar
Barber, B., and Odean, T.. “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” Quarterly Journal of Economics, 116 (2001), 261–292.CrossRefGoogle Scholar
Barberis, N.; Huang, M.; and Santos, T.. “Prospect Theory and Asset Prices.” Quarterly Journal of Economics, 116 (2001), 1–53.CrossRefGoogle Scholar
Barberis, N.; Huang, M.; and Thaler, R.. “Individual Preferences, Monetary Gambles and Stock Market Participation: A Case for Narrow Framing.” American Economic Review, 96 (2006), 1069–1090.CrossRefGoogle Scholar
Benartzi, S., and Thaler, R.. “Myopic Loss Aversion and the Equity Premium Puzzle.” Quarterly Journal of Economics, 110 (1995), 73–92.CrossRefGoogle Scholar
Brown, K.; Harlow, W. V.; and Starks, L. T.. “Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry.” Journal of Finance, 51 (1996), 85–110.CrossRefGoogle Scholar
Chevalier, J., and Ellison, G.. “Risk Taking by Mutual Funds as a Response to Incentives.” Journal of Political Economy, 105 (1997), 1167–1200.CrossRefGoogle Scholar
Coval, J., and Shumway, T.. “Do Behavioral Biases Affect Prices? ” Journal of Finance, 60 (2005), 1–34.CrossRefGoogle Scholar
Del Guercio, D., and Tkac, P.. “Star Power: The Effect of Morningstar Ratings on Mutual Fund Flow.” Journal of Financial and Quantitative Analysis, 43 (2008), 907–936.CrossRefGoogle Scholar
Dhar, R., and Zhu, N.. “Up Close and Personal: Investor Sophistication and the Disposition Effect.” Management Science, 52 (2006), 726–740.CrossRefGoogle Scholar
Elton, E.; Gruber, M.; and Blake, C.. “Incentive Fees and Mutual Funds.” Journal of Finance, 58 (2003), 779–804.CrossRefGoogle Scholar
Feng, L., and Seasholes, M.. “Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets?” Review of Finance, 9 (2005), 305–351.CrossRefGoogle Scholar
Frazzini, A. “The Disposition Effect and Underreaction to News.” Journal of Finance, 61 (2006), 2017–2046.CrossRefGoogle Scholar
Froot, K.; O’Connell, P. G. J.; and Seasholes, M.. “The Portfolio Flows of Institutional Investors.” Journal of Financial Economics, 59 (2001), 151–193.CrossRefGoogle Scholar
Gertner, R. “Game Shows and Economic Behavior: Risk Taking on Card Sharks.” Quarterly Journal of Economics, 108 (1993), 507–521.CrossRefGoogle Scholar
Gervais, S., and Odean, T.. “Learning to Be Overconfident.” Review of Financial Studies, 14 (2001), 1–27.CrossRefGoogle Scholar
Glaser, M., and Weber, M.. “Overconfidence and Trading Volume.” Geneva Risk and Insurance Review, 32 (2007), 1–36.CrossRefGoogle Scholar
Griffin, J.; Harris, J.; and Topaloglu, S.. “The Dynamics of Institutional and Individual Trading.” Journal of Finance, 58 (2003), 2285–2320.CrossRefGoogle Scholar
Grinblatt, M., and Keloharju, M.. “What Makes Investors Trade? ” Journal of Finance, 56 (2001), 589–616.CrossRefGoogle Scholar
Haigh, M. S., and List, J. A.. “Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis.” Journal of Finance, 60 (2005), 523–534.CrossRefGoogle Scholar
Kahneman, D., and Tversky, A.. “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica, 47 (1979), 263–291.CrossRefGoogle Scholar
Levich, R., and Thomas, L.. “The Significance of Technical Trading Rule Profits in the Foreign Exchange Market: A Bootstrap Approach.” Journal of International Money and Finance, 12 (1993), 451–474.CrossRefGoogle Scholar
Linnainmaa, J. “The Anatomy of Day Traders.” Working Paper, Helsinki School of Economics (2003).CrossRefGoogle Scholar
List, J. A. “Does Market Experience Eliminate Market Anomalies? ” Quarterly Journal of Economics, 118 (2003), 41–71.CrossRefGoogle Scholar
Locke, P., and Mann, S. C.. “Professional Trader Discipline and Trade Disposition.” Journal of Financial Economics, 76 (2005), 401–444.CrossRefGoogle Scholar
Neely, C. J.; Weller, P.; and Dittmar, R.. “Is Technical Analysis in the Foreign Exchange Market Profitable? A Genetic Programming Approach.” Journal of Financial and Quantitative Analysis, 32 (1997), 405–426.CrossRefGoogle Scholar
Odean, T. “Are Investors Reluctant to Realize Their Losses.” Journal of Finance, 53 (1998), 1775–1798.CrossRefGoogle Scholar
Okunev, J., and White, D.. “Do Momentum-Based Strategies Still Work in Foreign Currency Markets? ” Journal of Financial and Quantitative Analysis, 38 (2003), 425–447.CrossRefGoogle Scholar
Osler, C. “Currency Orders and Exchange Rate Dynamics: An Explanation for the Predictive Success of Technical Analysis.” Journal of Finance, 58 (2003), 1791–1820.CrossRefGoogle Scholar
Osler, C., and Chang, P. K.. “Head and Shoulders: Not Just a Flaky Pattern.” Working Paper, Federal Reserve Bank of New York (1995).CrossRefGoogle Scholar
Sias, R. “Institutional Herding.” Review of Financial Studies, 17 (2004), 165–206.CrossRefGoogle Scholar
Thaler, R. “Towards a Positive Theory of Consumer Choice.” Journal of Economic Behavior and Organization, 1 (1980), 39–60.CrossRefGoogle Scholar
Thaler, R., and Johnson, E.. “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice.” Management Science, 36 (1990), 643–660.CrossRefGoogle Scholar
Wermers, R. “Mutual Fund Herding and the Impact of Stock Prices.” Journal of Finance, 54 (1999), 581–622.CrossRefGoogle Scholar