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lo-behavioral - Fear and Greed in Financial Markets A...

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Fear and Greed in Financial Markets: A Clinical Study of Day-Traders * Andrew W. Lo , Dmitry V. Repin , and Brett N. Steenbarger †† First Draft: December 27, 2004 This Revision: March 22, 2005 Abstract We investigate several possible links between psychological factors and trading performance in a sample of 80 anonymous day-traders. Using daily emotional-state surveys over a five- week period as well as personality inventory surveys, we construct measures of personality traits and emotional states for each subject and correlate these measures with daily normal- ized profits-and-losses records. We find that subjects whose emotional reaction to monetary gains and losses was more intense on both the positive and negative side exhibited signif- icantly worse trading performance. Psychological traits derived from a standardized per- sonality inventory survey do not reveal any specific “trader personality profile”, raising the possibility that trading skills may not necessarily be innate, and that different personality types may be able to perform trading functions equally well after proper instruction and practice. Keywords : Behaviorial Finance; Market Psychology; Market Efficiency. JEL Classification : G12 * Research support from the MIT Laboratory for Financial Engineering is gratefully acknowledged. We thank Nicholas Chan, Mike Epstein, David Hirshleifer, Svetlana Sussman, and conference participants at the American Economic Association’s 2005 Annual Meetings for helpful comments and discussion. We are especially grateful to Linda Bradford Raschke for allowing us to recruit volunteers from her training program, and to all of the anonymous subjects of our study for their participation. MIT Sloan School of Management, 50 Memorial Drive, E52–432, Cambridge, MA 02142 (corresponding author). MIT Laboratory for Financial Engineering, One Broadway, Cambridge, MA 02142. †† SUNY Upstate Medical University, Department of Psychiatry and Behavioral Sciences, 713 Harrison Street, Syracuse, New York 13210.
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Contents 1 Introduction 1 2 Background and Literature Review 2 2.1 Emotion, Personality, and Preferences . . . . . . . . . . . . . . . . . . . . . . 5 2.2 Measuring Emotional Response . . . . . . . . . . . . . . . . . . . . . . . . . 6 3 Experimental Protocol 8 4 Results 11 4.1 Personality Traits and Trading Performance . . . . . . . . . . . . . . . . . . 16 4.2 Emotional States and Trading Performance . . . . . . . . . . . . . . . . . . . 16 5 Conclusions 18 References 21
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1 Introduction The rationality of financial markets has been one of the most hotly contested issues in the history of modern financial economics. Recent critics of the Efficient Markets Hypothesis ar- gue that investors are generally irrational, exhibiting a number of predictable and financially ruinous biases such as overconfidence (Fischoff and Slovic, 1980; Barber and Odean, 2001; Gervais and Odean, 2001), overreaction (DeBondt and Thaler, 1986), loss aversion (Kah- neman and Tversky, 1979; Shefrin and Statman, 1985; Odean, 1998), herding (Huberman and Regev, 2001), psychological accounting (Tversky and Kahneman, 1981), miscalibration of probabilities (Lichtenstein, Fischoff, and Phillips, 1982), and regret (Bell, 1982; Clarke, Krase, and Statman, 1994).
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