1. Behavioral Finance DeBondt and Thaler April 9, 2013 Behavioral Finance Economics 437

2. Behavioral Finance DeBondt and Thaler April 9, 2013 DeBondt and Thaler: “Does the Stock Market Overreact” (1985) L – three year loses W – three year winners Question: How do the W’s do in the next three years? How do the L’s do in the next three years? Other things worth noting Almost all of the impact is in January When the W portfolios are formed, they have very high P/E ratios, the L portfolios have low P/E ratios at the time of formation

3. Behavioral Finance DeBondt and Thaler April 9, 2013 DeBondt-Thaler conclusions Definite evidence of mean reversion (a form of serial correlation): L portfolios consistently outperform W portfolios 19.6 % better than the market after end of 3 years W portfolios consistently underperform the market 5 % less than the market after end of 3 years

4. Behavioral Finance DeBondt and Thaler April 9, 2013 Interesting facts Most of the excess returns are in January Loser effect more pronounced: Losers earned 19.6 % more than the market Winners earn 5.0 % less than the market Loser portfolio minus Winner portfolio return = 24.6 %!!!!! Most of the return difference is during 2 nd and 3 rd year Larger loses become larger winners; larger winners become larger losers

5. Behavioral Finance DeBondt and Thaler April 9, 2013 Criticism of F-F and D-T Kothari, Shanken, Sloan 1995 Chan (1988) Zarowin (1990)

6. Behavioral Finance DeBondt and Thaler April 9, 2013 Kothari, Shanken, Sloan 1995 F-F are wrong Beta does matter (explains returns of 6 to 9 % per year) KSS uses “annual” not “monthly” betas B/M matters, but not as much as you think Data snooping Survivor bias in the data

7. Behavioral Finance DeBondt and Thaler April 9, 2013 Chan 1988 (on DeBondt-Thaler) Risks of loser are greater than risks of winners So, they should get higher returns But they don’t really, after adjusting for transaction costs

8. Behavioral Finance DeBondt and Thaler April 9, 2013 Zarowin (1990) Losers tend to be small stocks When losers are compared to winners of equal size, there is little evidence of any return discrpancy When winners are smaller than losers, winners outperform losers

9. Behavioral Finance DeBondt and Thaler April 9, 2013 Lakonishov, Shleifer, Vishny, 1994 Questions: Do value stocks really beat out growth stocks (the F-F issue revisited)? Are value stocks actually riskier Is there a reason that value stocks do better? Answers: Yes, by 10 – 11 percent annually No, they outperform is all periods Yes, future earnings of value stocks are better than predictions – opposite for growth stocks

10. Behavioral Finance DeBondt and Thaler April 9, 2013 The End