Through eight experiments, we show that using red color to represent financial data impacts individuals' risk preferences, expectations of future stock returns, and trading decisions. The effects are not present in colorblind individuals and are muted in China, where red represents prosperity. Other colors, including yellow and blue, do not generate the same effects.
We find that when investors view potential financial losses in red, compared to black, the propensity of taking risk is reduced significantly. Specifically, individuals take approximately 20% less risk when shown potential financial losses in red color. Our results show that when individuals view negative historical stock price data in red, compared to black, their expectations about future returns are reduced significantly. That is, investors are more pessimistic, expecting continuing price declines in the future, while individuals who view the same information, but in black, expect the price trend to reverse, i.e., they predict that prices will rise in the future. We also find that red color reduces investors’ reported willingness to purchase stocks, by almost 15%, all else equal.
We use the 2008 Mumbai terrorist attacks as a natural experiment to examine how exposure to extreme stress affects financial decision making, as measured by investors’ stock trading activity and performance. We find that Mumbai investors trade less, perform worse, take longer time to react to corporate news announcement, are less likely to initiate trades on new stocks, and perform worse on familiar stocks compared with other traders. Collectively, our findings are most consistent with impairment of cognitive ability after exposure to prolonged and extreme stress.