Do Behavioral Biases Affect Prices?

Authors: JOSHUA D. COVAL¹; TYLER SHUMWAY²

Source: The Journal of Finance, Volume 60, Number 1, February 2005 , pp. 1-34(34)

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Abstract:

This paper documents strong evidence for behavioral biases among Chicago Board of Trade proprietary traders and investigates the effect these biases have on prices. Our traders appear highly loss-averse, regularly assuming above-average afternoon risk to recover from morning losses. This behavior has important short-term consequences for afternoon prices, as losing traders actively purchase contracts at higher prices and sell contracts at lower prices than those that prevailed previously. However, the market appears to distinguish these risk-seeking trades from informed trading. Prices set by loss-averse traders are reversed significantly more quickly than those set by unbiased traders.

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1540-6261.2005.00723.x

Affiliations: 1: 1Harvard Business School 2: 2University of Michigan Business School

Publication date: 2005-02-01