Publications
with Christine Laudenbach and Martin Weber, in: Management Science, Volume 69, Issue 6, June 2023, pp. 3157-3758
We experimentally study how presentation formats for return distributions affect investors' diversification choices. We find that sampling returns alleviates correlation neglect and constitutes an effective way to improve financial decisions. When participants get a description of the probabilities for outcomes of the joint return distribution, we confirm the findings of others that investors neglect the correlation between assets in their diversification choices. However, when participants sample from the joint distribution, they change their allocation between two assets in response to a change in their correlation in the predicted direction. The results are robust across two experiments that have participants with varying experience (students vs. private investors).
with Martin Weber, in: Journal of Finance, Volume 76, Issue 2, April 2021, pp. 797-844
How do investors perceive dependence between stock returns? And how does their perception of dependence affect investments and stock prices? We show experimentally that investors understand differences in dependence, but not in terms of correlation. Participants invest as if applying a simple counting heuristic for the frequency of comovement. They diversify more when the frequency of comovement is lower even if correlation is higher due to dependence in the tails. Building on our experimental findings, we empirically analyze U.S. stock returns. We identify a robust return premium for stocks with high frequencies of comovement with the market return.
with Florens Focke and Stefan Ruenzi, in: Review of Financial Studies, Volume 33, Issue 10, October 2020, pp. 4676-4720
Using daily advertising data, we analyze the short-term effects of advertising on investor attention and on financial market outcomes. Based on various investor attention proxies, we show that advertising positively affects attention. However, it has only little impact on turnover and liquidity. Most importantly, short-term stock returns are not significantly influenced by advertising. Further results suggest that previous findings of an economically significant positive relation between advertising and returns are due to reverse causality. Thus, the belief that stock prices can be temporarily inflated via advertising is misguided.
with Stefan Ruenzi and Florian Weigert, in: Journal of Banking and Finance, Volume 115, June 2020, 205809
We merge the literature on downside return risk and liquidity risk and introduce the concept of extreme downside liquidity (EDL) risks. The cross-section of stock returns reflects a premium if a stock's return (liquidity) is lowest at the same time when the market liquidity (return) is lowest. This effect is not driven by linear or downside liquidity risk or extreme downside return risk and is mainly driven by more recent years. There is no premium for stocks whose liquidity is lowest when market liquidity is lowest.
Working Papers
with J. Aislinn Bohren, Josh Hascher, Alex Imas, and Martin Weber
Link to instructions of experiments
We propose a framework where perceptions of uncertainty are driven by the interaction between cognitive constraints and the way that people learn about it — whether information is presented sequentially or simultaneously. People can learn about uncertainty by observing the distribution of outcomes all at once (e.g., seeing a stock return distribution) or sampling outcomes from the relevant distribution sequentially (e.g., experiencing a series of stock returns). Limited attention leads to the overweighting of unlikely but salient events—the dominant force when learning from simultaneous information—whereas imperfect recall leads to the underweighting of such events—the dominant force when learning sequentially. A series of studies show that, when learning from simultaneous information, people are overoptimistic about and are attracted to assets that mostly underperform, but sporadically exhibit large outperformance. However, they overwhelmingly select more consistently outperforming assets when learning the same information sequentially, and this is reflected in beliefs. The entire 40-percentage point preference reversal appears to be driven by limited attention and memory; manipulating these factors completely eliminates the effect of the learning environment on choices and beliefs, and can even reverse it.
with Martin Weber
Does frequent outperformance cause investors to buy? If so, do investors have a preference to outperform most of the time, or does frequent outperformance bias beliefs about the risk and return of an asset? In several randomized controlled trials, we show that retail investors purchase frequently outperforming assets, even at the cost of large infrequent underperformance and when assets are first-order stochastically dominated. An experiment with asset management professionals confirms that a large fraction of financial intermediaries anticipates investors' attraction to frequent outperformers. The evidence supports a belief-based mechanism, where frequent outperformance causes overoptimism about an asset's risk and return. Our findings have implications for fund management, the design and regulation of structured products, and for the debate on the (ir)relevance of systematic risk for portfolio choice and asset pricing.
with Martin Weber
Do investors incorporate diversification benefits of low-correlation assets? Are they able to? Experimental evidence rejects correlation neglect or pure narrow framing when investors are presented with return samples from joint distributions. At the same time, investors hold views contradicting textbook portfolio selection models, casting doubt on their ability to incorporate diversification benefits into portfolio choice. Carefully controlling for a newly discovered mechanism linking dependence to portfolio choice via biased beliefs, we show that investors do not react to changes in diversification benefits. Diversification benefit neglect is robust to different presentation formats, including descriptions of simple joint return distributions and sampling portfolio returns, suggesting that incorporating diversification benefits of realistic variations in correlation is beyond investors' capabilities.
with Petri Jylhä
We reconcile the empirically flat relation between historical betas and stock returns (flat security market line) with the common usage of the CAPM based on historical betas in valuation. Analysts bias cash flow growth expectations upwards for high-beta firms, so that the value-reducing effect of higher historical systematic risk cancels out and buy/sell-recommendations remain unrelated to beta. The association between beta and growth overestimation is driven by estimates conventionally used in the industry (e.g., Bloomberg betas), suggesting that analysts adjust growth expectations to offset beta's valuation effects, instead of exhibiting a coincidentally higher overoptimism for higher-beta firms.
with Christoph Merkle
In three large online experiments, we study how investors assess the relationship between their portfolio and the stock market. Participants either select a portfolio of stocks or are randomly assigned a portfolio from a U.S. stock market index. They state their portfolio return expectations conditional on different market outcomes, allowing us to calculate implied beliefs about portfolio beta. We find a general underestimation of beta, which is particularly strong for downside beta. This asymmetric assessment of dependence is amplified for participants who select a portfolio themselves instead of receiving a randomly assigned portfolio. They believe their portfolio goes up with the market but does not come down with it. We confirm such biased beliefs about beta also in a sample of financial professionals and with several novel belief elicitation methodologies. Our findings reveal yet unknown patterns in beliefs about systematic risk, which shed light on the source of investor overconfidence.
with Alexander Hillert
We analyze the relation between firm visibility and stock returns using comprehensive news coverage data of U.S. firms. Carefully controlling for firm characteristics, we find that persistently higher levels of firm visibility predict higher returns. Visibility also predicts higher sales and profitability growth, as well as improvements in corporate governance like, for example, enhanced performance-induced CEO turnover. The visibility return premium is concentrated in earnings announcement months and industry-years when the visibility-fundamentals sensitivity is high. Overall, the evidence is consistent with visibility creating value through a monitoring and advertising channel, while stock markets underprice the benefits of firm visibility.
with Alok Kumar and Stefan Ruenzi
One of the most salient events for a stock is being a daily winner or loser: these stocks are highlighted prominently in the media, leading to investor attention spikes. We demonstrate that ranked stocks underperform unranked stocks by over 1.50% during the month after the ranking, in line with attention-induced overpricing. To establish causality, we introduce an identification strategy that exploits unconventional return-measurement periods. We show that the underperformance of daily winners and losers provides a new attention-based solution for the idiosyncratic volatility puzzle and related return patterns, and thus a simple unifying explanation for important asset pricing anomalies.
with Fabian Brunner
We show that a substantial part of information acquisition and trading in stock markets is driven directly by salient returns, above and beyond the effects of underlying causes of returns. To establish causality, we first analyze overnight earnings announcements. Larger surprises lead to more information acquisition only after the market opens, consistent with salient returns as a cause. Second, we exploit Wall Street Journal rankings to show that prominently placed salient returns drive information acquisition and trading. Finally, we document that stocks experiencing salient returns are particularly mispriced, in line with return-induced uninformed trading as a major moderator of anomalies.