Trading decisions of individual investors Evidence of psychological Essay

Trading decisions of individual investors Evidence of psychological biases - Essay Example The Common Stock Investment Performance of Individual Investors†, Barber and Odean (2000). Barber and Odean (2000) studied data of stock market transactions undertaken by 78,000 households, from January 1991 to December 1996. Under the overconfidence model, investors who are overconfident about executing a profitable trade will trade more frequently in the market, and because much of their market action will be based on emotion (overconfidence) rather than deliberate and pragmatic study, their trades will be of lower expected utility. The resulting net return of households with high turnover will be inferior to those less frequently traded accounts. By comparison, the rational expectation framework of Grossman and Stiglitz posit that when investors trade, it is because they perceive that the marginal benefit they will realize is greater than the marginal cost they will incur. Since such investors trade only when such opportunity presents itself, which probably will be as often as not, then the rational investor transacts less frequently, incurring a lower aggregate transaction cost. The study discovered that households that have lower turnover (and thus traded less frequently) had larger accounts that those households that had higher turnover. This may be explained by the fact that investors who trade less frequently are longer-term investors whose objective in entering the market is for capital appreciation rather than the â€Å"quick buck†. They will tend to select stocks of â€Å"blue chip†, investor, quality, and to maintain that position for years. The earlier investigation done by Odean (1998) sought to discover whether or not individual investors tended to maintain a losing position too long and, conversely, close out on their gaining stocks too soon. This has direct bearing on the Prospect Theory by Kahneman and Tversky (1979), originally conceived as a