Social Interaction and Investing Insights
Conversation on social, economic, and finance paradigms influencing investing behaviors. Explore impacts of social interactions on stock market participation, neighborly influence, and social norms shaping investment decisions. Dive into the phenomena of herding and social influences in investment practices.
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Presentation Transcript
Chapter 9 Social Interaction and Investing
Conversation Social economic and finance paradigm Professor Hirshleifer s 2020 presidential address to the American Finance Association Conversation allows for the rapid exchange of information, opinions, and emotions Ramifications are that the resulting actions can generate price bubbles, herding, and investor sentiment 2
Social People and Investing Interaction makes people more comfortable investing Survey of 7,500 households in Health and Retirement Study of Households found that: Social households are more likely to invest in the stock market This is magnified if the household is in a high stock-market participation community 3 Harrison Hong, Jeffrey D. Kubik, and Jeremy C. Stein, Social Interaction and Stock-Market Participation, Journal of Finance 59(2004): 137 163
Neighborly Influence Using both IRS data or stock brokerage data, studies find that When a neighbor increases purchases in an industry by 10%, the household increases ownership by 2% Neighbor increases ownership in local company, household also increases by the same amount This word-of-mouth information diffusion is stronger in states that are considered to be more social Professional investor neighbors also have similar portfolios Especially when they have the same ethnic background Sharing a culture makes them more likely to socially connect See Zoran Ivkovic and Scott Weisbenner, Information Diffusion Effects in Individual Investor s Common Stock Purchases: Covet They Neighbors Investment Choices, Review of Financial Studies 20:4(2007): 1327 1357, and Jeffery R. Brown, Zoran Ivkovic, Paul A. Smith, and Scott Weisbenner, Neighbors Matter: Causal Community Effects and Stock Market Participation, Journal of Finance 63:3(2008): 1509 1531. Pool, Stoffman, and Yonker, 2015, The People in Your Neighborhood: Social Interactions and Mutual Fund Portfolios, Journal of Finance 70(6), 2679-2731. 4
Social Influences Social norms The informal opinions, rules, and procedures of a group. Your peers and social groups influence your investment participation Herding The movement into or out of a stock or industry of companies by large groups of investors. Desire for unprofitable Internet companies in late 1990s Meme investors herding into GameStop 5
The Friends You Keep Peer effects impact your investment choices Pension plan participation in 11 different libraries at a large public university Librarians should be able to find the information that contributing is a good idea Yet, participation is highly dependent on work location Esther Duflo and Emmanuel Saez, Participation and Investment Decisions in a Retirement Plan: The Influence of Colleagues Choices, Journal of Public Economics 85(2002): 121 148 6
Wincapita Ponzi Scheme Finnish investment operation that was active from 2003 to 2008 Word-of-mouth information dissemination only It offered investors large returns, initially claiming that the profits were generated by sports betting and later by currency trading (but there was never any cash flow generated) Profits were simply the incoming cash flows came from new and existing investors Ultimately growing to over 10,000 members, approximately 0.2% of the total population of Finland Exceeded 100 million. The average amount invested was 15,100 with a median of 8,000 Personal relationships made the collapse of the scheme emotionally tragic large financial losses, destroyed relationships, several mentions of suicides, divorces, and mental health problems 7 Ville Rantala, How Do Investment Ideas Spread through Social Interaction? Evidence from a Ponzi Scheme, The Journal of Finance 74 (2019): 2349-2389.
Effective Seminars and Social Interaction Consider this experiment with invitations to a DC fair at a major university: Some departments offered a $20 reward to some of their faculty for going, other departments did not. People who knew about the $20 reward were five times more likely to attend than other invitees Colleagues of $20 invitees were three times more likely to attend than those who didn t know about it! $20 invitees and their colleagues were more likely to enroll than other invitees. 8 Continued
Investment Clubs Performance From NAIC surveys, the financial press claim the 60% to 67% of clubs beat the market. Surveys are biased The actual performance is not as flattering. From brokerage data, clubs underperform 9
10 Brad M. Barber and Terrance Odean, Too Many Cooks Spoil the Profits: Investment Club Performance, Financial Analysts Journal (January/ February 2000): 17 25
Club Dynamics Two types of investment clubs: 1. Clubs serious about socialization 2. Clubs serious about investing 11
Decision Process of Socializing Clubs Potential stocks are proposed with little data. Arguments for purchasing are more story- telling. Very little analysis. Little debate. 12
Decision Process of Investing Clubs Formal procedures for proposing stocks. Have specific info available Fill out work sheets Have investment criteria Like positive earnings, dividends, PE lower than 30, etc. These procedures help overcome emotional and psychological biases. 13
Social media is the new talk Twitter German scholars investigated the relationship between 250,000 stock-related tweets and activities in the stock market The sentiment of the tweets is positively related to the stock returns Positive sentiment exhibited in the tweets is associated with positive returns A higher number of tweets is connected to a larger volume of stock trading A greater disagreement with the tweets is related to more volatility in the market 14 Timm O. Sprenger, Andranik Tumasjan, Philipp G. Sandner, and Isabell M. Welpe, Tweets and Trades: The Information Content of Stock Microblogs, European Financial Management 20(2014), 926 957.
Language Matters! The difference between the right word and the almost right word is the difference between lightning and the lightning bug. Mark Twain Words are inherently less objective than numbers Some words create vivid imagery that is emotionally interesting Apple s sales jumped versus Apple s sales increased 15
A language experiment Study the impact of vivid words during bull and bear markets During bull market Subjects divided into those having long and short positions Positive news is framed in either vivid or pallid phrases Asked for a forecast of the future market performance The long position group gave similar forecasts no matter the vividness of the news Short position group s forecasts were impacted higher predictions given for more vividly phrased news 16 Continued
A language experiment During bear market Long position investors were impacted It is contrarian investors who are most impacted by the hype, not the popular consensus investors! 17 Jeffrey Hales, Xi (Jason) Kuang, and Shankar Venkatatraman, Who Believes the Hype? An Experimental Examination of How Language Affects Investor Judgments, Journal of Accounting Research 49(2011): 223 255
BUY, BUY, BUYSELL, SELL, SELL Jim Cramer s Mad Money Vivid language is augmented by flashing lights & horns Does this showmanship impact people s behavior? For the stocks recommended: There is a dramatic short-term price reaction, stocks surge nearly 2.5 percent the night of the recommendation That return dissipates over the next few weeks The return is higher for smaller companies and for stocks that get highlighted during a show with a larger viewership In the long run, they do not earn extra returns over what they should given their level of risk This attention to specific stocks causes a temporary mispricing because of the short-term demand it causes for them 18 Joseph Engelberg, Caroline Sasseville, and Jared Williams, Market Madness? The Case of Mad Money, Management Science 58(2012), 351 364.
A Rose.com by any other name Computer Literacy Inc. changed its name to fatbrain.com The stock price went up 33% in one day! From mid-1998 to mid-1999, 147 firms changed their name to a dotcom type name During the 3-weeks after the change, the average stock return beat the market by 38% Some of these firms had little Internet experience 19 Michael Cooper, Orlin Dimitrov, and Raghavendra Rau, A Rose.com by Any Other Name, Journal of Finance 56(2001): 2371 2388
Growth, Value ---- BUD, YUM, LUV Mutual fund names Some mutual funds change their name to reflect the previous period s hot style value, growth, small stocks, and so on This name change causes 28 percent more money to flow into the fund than otherwise expected Do cute ticker symbols add value? Do cute ticker symbols like BUD or LUV catch investors attention more than JWN or ZNH? Yes. Firms with likable ticker symbols have higher valuations (PE and M/B ratios) Michael Cooper, Huseyin Gulen, and Raghavendra Rau, Changing Names With Style: Mutual Fund Name Changes and Their Effects on Fund Flow, Journal of Finance 60 (2005): 2825 2858. Xuejing Xing, Randy I. Anderson, and Yan Hu, What s a Name Worth? The Impact of a Likeable Stock Ticker Symbol on Firm Value, Journal of Financial Markets 31(2016): 63 80. 20
Short-term Focus People often get a speculator s short-term focus instead of an investment focus Consider Sharon, who was interviewed by the PBS show Frontline She invested her family s entire life savings into two tiny tech stocks: To tell you the truth, I don t even know the name of it. I know the call letters are AMLN. It s supposed to double by August. This behavior requires faith and social validation 21
Summary People learn through interacting with each other. We talk about our beliefs about investing and seek the opinions of others. The opinions of our neighbors, friends, and colleagues impact our decisions. Investment clubs are a formalized process of investing socialization. But clubs with a stricter investment procedure have more success than clubs focused on social activities. Continued 22
Summary Language and name are important The media transmits much of the information we use to make investment decisions. Vivid language, or hype, influences the investors with contrarian positions. Unfortunately, investors tend to react too quickly to news stories. This short-term focus can be costly. Tweets matter too. 23
