Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders / Francis Larson, John A. List, Robert D. Metcalfe.

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Larson, Francis

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w22605.Publication details: Cambridge, Mass. National Bureau of Economic Research 2016.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: Behavioral economists have recently put forth a theoretical explanation for the equity premium puzzle based on combining myopia and loss aversion. Complementing the behavioral theory is evidence from laboratory experiments, which provide strong empirical support consistent with myopic loss aversion (MLA). Yet, whether, and to what extent, such preferences underlie behaviors of traders in their natural domain remains unknown. Indeed, a necessary condition for the MLA theory to explain the equity premium puzzle is for marginal traders in markets to exhibit such preferences. Using minute-by-minute trading observations from over 864,000 price realizations in a natural field experiment, we find data patterns consonant with MLA: in their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information. Beyond testing theory, these results have important implications for efficient resource allocation as well as characterizing the optimal structure of social and economic policies.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w22605 (Browse shelf(Opens below))	Not For Loan

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September 2016.

Behavioral economists have recently put forth a theoretical explanation for the equity premium puzzle based on combining myopia and loss aversion. Complementing the behavioral theory is evidence from laboratory experiments, which provide strong empirical support consistent with myopic loss aversion (MLA). Yet, whether, and to what extent, such preferences underlie behaviors of traders in their natural domain remains unknown. Indeed, a necessary condition for the MLA theory to explain the equity premium puzzle is for marginal traders in markets to exhibit such preferences. Using minute-by-minute trading observations from over 864,000 price realizations in a natural field experiment, we find data patterns consonant with MLA: in their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information. Beyond testing theory, these results have important implications for efficient resource allocation as well as characterizing the optimal structure of social and economic policies.