In recent years the understanding of behavioral risk taking has gained the recognition of its impact on financial markets and their dynamics.
We need to compare how risk taking deviate from rational decision making, in order to suggest financial instruments that will compensate for this deficiency that drives investors into losses.
The first work in this Behavioral Finance series was conducted in collaboration with Eli Arditi, my computer science M.Sc Student from the Technion and Prof. Eldad Yechiam.
In a series of laboratory experiments we tested participant reactions to the trading of risky assets versus safe assets. We found that following losses, investors were more likely to switch their investments choices without any new financial information. We coin this risk taking behavior as ‘agitated losses’, as if the sting of these losses prompts us to take action without any apparent reason. We conclude our results in the following paper: Loss restlessness and gain calmness: durable effects of losses and gains on choice switching.
A second insight rising from the previous behavioral investigation of loss affects, is the understanding that following losses before an action is taken, people tend to inquire information regarding the loss leading effect and origins. In other words, losses draw our attention and drives us to look for new information about the cause of the losses.
This explain why suffering losses is essential to educate people. We have to inflict losses to stimulate the student attention. In order to empirically examine the hypothesis that losses drives us to ‘search behavior’ for information acquisition. Together with Eli Arditi and Prof. Eldad Yechiam we analyzed the 5-Years historical google search trends (this data was downloaded from google analytics and analysed). The empirical evidence implicitly shows that following stock market significant loss events the number of google searches for the stock reports rose dramatically and the interest in the stock stayed high for several days until interest completely decayed back to normal. For further interest in these results please look into our empirical paper: Association between Stock Market Gains and Losses and Google Searches. Further research in this area would involve developing a financial training program that will diminish this
irrationality and bring us a more calm risk taking behavior as well as a clearer analysis, motivated by informed search behavior instead of attention driven by losses.
Another extremely well studied behavioral risk effect, is the investor’s behavior leading to financial bubbles. We witness this phenomena repeatedly and in every known market. In a series of laboratory experiments with eight participants, we simulated a buyers-sellers limit order market. The investors have the choice of either buying or selling a risky asset. The resulting analysis shows that sellers are more active in offering their asset and are compensated with a monetary premium for “marketing behavior” while buyers numbness leads them to over pay. This irrational effect is completely diminished once investors can both buy and sell. The conclusion is that we should be motivated to constantly engage in selling actions in order to avoid overpaying for risky assets. The result of the empirical study conducted with Prof Eldad Yechiam and PhD student Amitay Kauffman was summarized in the following paper: "Buyer-Seller gaps in asset market bubble metrics"