Seventh Annual Finance Symposium

The Seventh Annual Maryland Finance Symposium, co-chaired by Lemma Senbet, William E. Mayer Chair Professor of Finance, and Vojislav Maksimovic, Bank of America Professor of Finance, provides a biennial forum for presentation and discussion of recent research by top scholars in the field.

This years forum, held May 29-31, 2007, focused on Behavioral Finance and included papers discussing the limits of arbitrage, CEO overconfidence and myopia, herding and over/under-reaction in financial markets, trading behavior and volume, market timing and consumer finance.

In the Friday morning session, Daniel Dorn, Drexel University, presented a paper co-authored with Paul Sengmueller, Universiteit van Amsterdam, titled Trading as Entertainment. Dorn analyzed trading data from a German discount broker, gathering complete transaction histories from 21,000 clients and then conducting a survey of 1,300 of those clients. The clients were asked to what degree they enjoyed investing and risky propositions, responding to statements such as, Games are only fun when money is involved.

Dorn found that excessive turnover more than could be accounted for by rational measures might be explained by peoples enjoyment of the thrill of investing, treating it as a hobby or other leisure activity. He found that younger men tended to have more excess trading activity, and that portfolio returns led trading activity, perhaps because people enjoy investing more when they are getting positive results, in much the way that people enjoy gambling more when they are winning. People also seem to trade more because they are overconfident, thinking they are more competent than the average investor.

In the Friday afternoon session, Devin Shanthikumar of Harvard University presented a paper co-authored with Ulrike Malmendier of the University of California, Berkeley. In this paper the authors show evidence that security analysts are able to communicate two different messages to two different audiences. Specifically, they show that less-sophisticated small traders are more likely to be influenced by analyst recommendation such as buy, sell and hold whereas the more sophisticated large traders are more likely to be influenced by earnings-per-share forecasts. They also examine what impact (if any) an analysts affiliation with the investment bank has on the trading strategy employed by investors. The authors show that the sophisticated investor adjusts an analysts forecast for the analysts affiliation whereas the less sophisticated investor does not do so. They also show that analysts are possibly issuing overly optimistic recommendations to generate profits via commissions and underwriting but are displaying their true competence via their earnings forecasts.

The presentation was followed by a short commentary by Gerard Hoberg, assistant professor of finance, who summarized key findings of the paper and also highlighted some of its strengths and weaknesses.

Rodrigo Verdi of the Massachusetts Institute of Technology presented a paper co-authored with Jeffrey Ng and Irem Tuna, both from the University of Pennsylvania. In their paper the authors showed that investors tended to underreact to forecast surprises and that it was possible to generate abnormal returns by employing a trading strategy that takes this into account. The authors also found that the underreaction tended to be greater for surprise good news forecasts than for surprise bad news forecasts. The authors also showed that higher quality forecasts tended to be associated with smaller underreactions.

One of the unexpected highlights of the Maryland Finance Symposium was an impromptu panel discussion over lunch on behavioral finance. The participants were noted finance scholars who had a strong opinion on behavioral finance. These included Simon Gervais of Duke University, Jay Ritter of the University of Florida, Chester Spatt of the Securities and Exchange Commission and Carnegie Mellon University, and finally Maryland's own Albert Pete Kyle, Smith Chair Professor of Finance. This lively and informal discussion was moderated by Vojislav Maksimovic.

The panel discussion was kicked off by Gervais who said that behavioral finance has long been the study of anomalies and in order to further this discipline it needs to move beyond that. Kyle provided a historical perspective on behavioral finance. He cited Adam Smiths Wealth of Nations and said that Smith described it as human nature to trade and barter. Kyle reminded the audience that the early economists were called moral philosophers, suggesting that there was a strong element of morality associated with the study of economics. Keynesian economics, Kyle said, was also strongly moral by nature and was tinged with socialism. He noted that behavioral finance as we understand it now came into existence just as Keynesian economics was dying out. The rise of behavioral finance was probably a way of keeping a certain Keynesian element alive but without associating it with any moral imperatives.

Noted economist Robert Shiller, professor at Yale University, author of Irrational Exuberance and pioneer in the field of behavioral finance, presented the keynote address.

Kyle also predicted that the study of economics is about to take a moral turn again. Whether it is aggressive data mining techniques or consumer lending practices, economists may be about to start taking closer looks at practices that may be judged as detrimental to consumers. Underlying this is probably a behavioral belief that some consumers are less smart than certain providers. These smarter providers then engage these not so smart consumers in games that result in losses for the consumers.

The informal nature of the panel discussion allowed for plenty of audience participation and also some good-natured laughs.

The papers presented at this conference are available online

▓ Sachin Agarwal, MBA candidate 2007, and Rebecca Winner, Office of Marketing Communications. Photography by Lisa Helfert.