Tuesday, June 17, 2014

Are Household Investors Noise Traders: Evidence from Belief Dispersion and Stock Trading Volume

A new paper from researchers at the Federal Reserve shows that retail investors—in America, at any rate—are a lot smarter than the professionals imagine. In fact, they have a bigger effect on the markets than the highly paid investment strategists of Wall Street.

Much of the economic literature assumes that ordinary investors are “noise” traders who deal at random. They trade too often, it is thought, and are susceptible to behavioural biases such as over-optimism and loss-aversion.

Strikingly, the researchers find that the views of retail investors show a sharp rise in dispersion just before recessions, whereas the views of professional forecasters do not diverge until the tail end of recessions. In other words, the amateurs are better at forecasting downturns than the experts.
This may be because the consumer surveys interview people with a wide range of backgrounds and from many different locations, whereas investment strategists are a tightly knit group, and may accordingly suffer from a herd mentality.

Read the full report

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