Volume 4, Number 4, 2004 Abstracts
© Copyright Erlbaum 2003

Bubble Jr.
David Dreman-Dreman Value Management

Riding the Wave of Sentiment: An Analysis of Return Consistency as a Predictor of Future Returns
Boyce Watkins-Syracuse University

This article analyzes the degree to which return consistency in the past predicts future returns. I show that consistency is a strong predictive measure for future stock returns. In a portfolio context, positively consistent stocks exhibit positive future risk-adjusted returns, and negatively consistent stocks exhibit negative future risk-adjusted returns. The results are economically and statistically significant over multiple subperiods. Also, odd return behavior persists for nearly two years after portfolio formation. Stocks that have been consistently positive (negative) for longer time horizons have higher (lower) risk-adjusted returns during the followingmonththan those thathavebeenconsistent for shorter time periods. Finally, high consistency enhances momentum when the two factors are allowed to interact. Thus, there appears to be strong path dependence in the momentum effect, and consistency in stock returns appears to be an important component of return predictability.

Investor Confidence and Returns Following Large One-Day Price Changes
Ray R. Sturm-Florida Atlantic University and the University of Central Florida

I hypothesize that post-event price behavior following large one-day price shocks is related to pre-event price and firm fundamental characteristics, and that these characteristics proxy for investor confidence. Several behavioral theories suggest how investors form their expectations, and I suggest four investor confidence hypotheses based on these theories. In addition to documenting further evidence of investor overreaction, my findings indicate that investors respond differently to negative price shocks than to positive price shocks. In particular, large price decreases generally drive positive post-event abnormal returns, while large price increases do not drive positive or negative abnormal returns. However, my main finding is that this relationship is altered when pre-event return and firm characteristics are introduced. This suggests that certain pre-event characteristics influence investor confidence, which in turn influences buying and selling decisions and thereby drives post-event returns. However, investor confidence appears to be lessened by a price shock effect.

Derivation of Asset Price Equations Through Statistical Inference
Gunduz Caginalp-University of Pittsburgh
Vladimira Ilieva-Dreman Foundation
David Porter-George Mason University
Vernon Smith-George Mason University

We develop a methodology to extract a quantitative model for behavioral effects in markets from empirical data. A set of 24 asset market experiments are utilized to derive an equation of price and its dependence on momentum, fundamental value, excess bid level and liquidity considerations. A difference equation is derived from a statistical analysis of the data. The methods are quite general and can be utilized in conjunction with other behavioral finance effects that influence price dynamics.

Simple and Complex Market Inefficiencies: Integrating Efficient Markets, Behavioral Finance, and Complexity
Edgar Peters-PanAgora Asset Management

Traditional capital market theory says that markets are efficient because investors are rational. The new school of behavioral finance says the opposite. Rather than solving problems "rationally," individuals tend to make biased decisions using pattern recognition techniques. However, what is rational and irrational may depend upon the type of problem we wish to solve and the method we use to solve it. If the market inefficiency is a simple objective problem, then "cool reason" should prevail. However, if the market is a complex system, then the value of data would be ambiguous making it more rational to use pattern recognition techniques. In this article we will find that rational investors would indeed keep certain types of mispricing from happening. Likewise, human behavior and the market complexity cause mispricing that cannot be arbitraged away. In the end, investors are irrational if they use the wrong method to solve a particular type of problem. By examining method and object we can find when investors are rational, when they are irrational. A non-mathematical model integrating efficient markets, behavioral finance, and complex systems is presented.

Regression to the Mean: One of the Most Neglected but Important Concepts in the Stock Market
Bernard I. Murstein-Connecticut College

The meaning of "regression to the mean" is discussed, as well as the consequences of failing to recognize its effect on research. The lack of performance persistence among stocks and mutual funds is explained as evidence of a lack of valid variance in the performance of stocks, resulting in steep regression-to-the-mean effects. The ubiquity of regression to the mean is illustrated by showing that it is an important factor in marriage as well as in mutual funds.

Research Elsewhere
Robert A. Olsen-California State University, Chico and Decision Research

Book Review
Robert A. Olsen-California State University, Chico and Decision Research