Many researchers in the field of behavioral finance relate the market/stock inactiveness to the behavior of investors in the market. Investors collect information from their peers and respond in the market without considering the fundamentals of the market or the stocks. Although psychology, human nature and other personal traits influence the investors to act in the market, in the world of uncertainty, simulating others’ actions may not fetch a good result in the long run. This trend of imitation and active participation is more pronounced in the emerging capital markets.

The first paper in this issue, “Herding and the Thin Trading Bias in a Start-Up Market: Evidence from Vietnam” by Vasileios Kallinterakis, analyzes the herd behavior in the context of the Vietnamese market and suggests that thinly traded structures can encourage herding tendencies. Using market data from a newly emerging Vietnamese market, the author establishes that thin trading introduces a positive bias over herding. However, this significant behavior disappears after correcting for thin trading. He interprets this through linking thin trading with the accumulation of excess demand/supply during active trading days as a result of the delayed execution of orders in illiquid settings.

The next paper, “Impact of Investors’ Lifestyle on Their Investment Pattern:

An Empirical Study” by Sushant Nagpal and B S Bodla, follows a survey method of research and attempts to study the lifestyle characteristics of the respondents and their control on investment alternatives. The study finds that the modern day investors are very mature and adequately cautious. In spite of the phenomenal growth in the security market, the individual investors prefer less risky investments such as life insurance, fixed deposits with banks and post offices, and secure kind of instruments. Occasions of blind investments are rare and a majority of investors are found to be using some source or reference group for taking their investment decisions. Though they are in the trap of some kind of cognitive misapprehension, such as overconfidence and narrow framing, they consider multiple factors and seek enormous information before entering into some kind of investment transactions. The authors also found that investors have made media as a part of their investment decision making tool. According to them, financial dailies, TV channels and peer groups play a vital role in making investment decisions.

One of the most prominent patterns in the financial markets is the propensity of investors to sell their winning stocks too quickly and to hold on to their losers too long. This tendency in behavioral finance is termed the disposition effect. The third paper, “Disposition Effect and Momentum: Prospect Theory and Mental Accounting Framework” by Mouna Boujelbène Abbes, Younès Boujelbène and Abdelfettah Bouri, examines the French market and the capability of the disposition effect to explicate return predictability. The authors test whether the disposition effect allows return predictability and momentum in stock prices. Using the French stocks quoted over the period 1995-2004, the authors measure the unrealized capital gains/losses based on historical prices and share volume. They also provide evidence that stocks with high past returns tend to have positive unrealized capital gains, while low past return stocks are more likely to generate unrealized capital losses. Their study, based on cross-sectional regressions, concludes that the capital gains overhang is the key variable that produces the profitability of a momentum strategy.

The last paper of the issue, “Rational Actors and Balancing Markets:

A Game-Theoretic Model” by Thomas Rupp, develops a model for energy market of Germany. The model explains the influence of balancing market on trading strategies in energy markets. To improve the understanding of the influence of balancing markets on trading strategies, the author undertakes a very simplified and concurrently one-stage approach to comprehend the optimal behavior of rational and passive participants on balancing markets. The study findings suggest that the model has a unique equilibrium and that no participant acts divergent to the aggregate market. This implies that either all market participants buy or sell additional power.

-- K K Ray
Consulting Editor