Date of Award
Doctor of Philosophy (PhD)
My dissertation consists of three chapters. In the first chapter, I show across three different settings that an individual's history of experiencing persistent processes can impact their beliefs. First, I examine analyst forecasts of earnings and show that forecasters who have covered firms with more autocorrelated earnings in the past are more extrapolative relative to their peers: they are relatively optimistic after high past earnings and relatively pessimistic after low past earnings. This generates predictable errors: after a good announcement in the previous period, firms that are covered by more extrapolative analysts on average will tend to have negative earnings surprises. Second, I examine individual investor trading behavior and find that individuals who have directly experienced more trending stocks will be more likely to purchase a stock following a positive return, and more likely to sell a stock following a negative return. Finally, I study survey data on the aggregate stock market, and find that individuals who have experienced the market being more autocorrelated in their years of financial experience tend to be more extrapolative in their forecasts. In the second chapter, I use data from Morningstar to study the relationship between recent returns to certain investment styles (e.g. "Large Value") and flows to mutual funds of that particular style. Consistent with the style investing hypothesis of Barberis and Shleifer (2003), mutual fund flows are positively related to recent returns of its associated Morningstar category. However, I find evidence that investors compare funds within categories as well: after controlling for a fund's own past return, the relationship between flows and recent returns of its category becomes negative. Furthermore, the comparison within-category is stronger than across categories. Investors tend to compare funds at the "edge" of a category (e.g. between Large Value and Mid Value) to other funds within its assigned category rather than funds on the other side of the edge. Both retail and institutional investors engage in within-style comparisons, but institutional investors are better at identifying which fund category to compare to. In the third chapter, I construct a measure of risk aversion under prospect theory (PTRA). The measure is based on how much a prospect theory agent is willing to pay to avoid a fair gamble along each point of the curve. Using data on individual stock turnover and mutual fund holdings, I calculate the PTRA of the average investor holding each stock. In the cross-section, stocks with high PTRA investors tend to underperform compared to stocks with low PTRA investors. The effect reverses over longer periods of time, consistent with price pressure from irrational investors. Finally, I show that the positive relationship between risk and return holds among stocks with low PTRA, but the opposite is true among stocks with high PTRA.
Zhao, Kevin, "Essays in Financial Economics" (2021). Yale Graduate School of Arts and Sciences Dissertations. 144.