Once Burned Twice Shy & It Could Have Been Worse: How Pain, Pleasure & Counterfactuals Affect The Repurchase o

1. Once Burned Twice Shy & It Could Have Been Worse: How Pain, Pleasure & Counterfactuals Affect The Repurchase of Stocks Previously Owned Michal Strahilevitz, Golden Gate University Terrance Odean, U.C. Berkeley Brad Barber, U.C. Davis

2. Once Burned Twice Shy & It Could Have Been Worse: How Pain, Pleasure & Counterfactuals Affect The Repurchase of Stocks Previously Owned Michal Strahilevitz, Golden Gate University Terrance Odean, U.C. Berkeley Brad Barber, U.C. Davis

3. BASIC LEARNING When a behavior gives you pleasure, you are more likely to repeat it. When a behavior causes you pain, you learn to avoid it.

16. Basic Learning Applied Correctly We have learned that fire causes pain, so we avoid it. Many people who attended this conference last year thought it was great, and so they returned this year. When someone makes us happy, we want to spend time with that person. When someone makes us unhappy, we want to avoid them.

17. What about Stock Trading?

21. Basic Learning Applied To Trading Investors are more likely to repurchase stocks they sold for a profit than to repurchase stocks they sold for a loss.

22. COUNTERFACTUAL REASONING We often compare what is to what might have been: “It would have been worse if…” “It would have been better if…” The “closer” we are to what might have been, the more regret we are likely to feel for an positive forgone outcome.

23. Google Inc. (GOOG)

24. COUNTERFACTUAL REASONING APPLIED TO TRADING If the stock has gone up since I sold it, I am less likely to buy it again. Why? Because I’d be better off had I never sold it to begin with. Regret avoidance. If the stock has down since I sold it, I am morelikely to buy it again. Why? Because I am better off than if I had never sold it to begin with. Regret reduction.

25. Regret Avoidance Applied to Trading Investors are more likely to repurchase a stock that has gone up in price since they sold it than to repurchase a stock that has gone down in price since they sold it.

26. Data Set 1: Large Discount Brokerage • January 1991 through November 1996 • 158,000 accounts. • 1,082,107 purchases: mean value $11,205. • 887,594 sales: mean value $13,707.

27. Data Set 2: Large Retail Brokerage • December 1997 through June 1999. • 665,533 individual accounts. • 3,974,998 purchases--mean value $15,209. • 3,219,299 sales--mean value $21,169.

28. Methodology for Examining“Once Burned Twice Shy” Hypothesis Reconstruct portfolios from trading records. Count purchases of stocks sold for gain in previous 12 months and purchases of stocks previously sold for loss in previous 12 months. Count opportunities to purchase stocks sold for gain in previous 12 months and opportunities to purchase stocks previously sold for loss in previous 12 months. Calculate proportion of opportunities where a repurchase occurred for “winner” and “loser” stocks.

29. “Once Burned Twice Shy” Predicts That… Number of prior winners repurchased Number of opportunities to repurchase a winner Should be greater than Number of prior losers repurchased Number of opportunities to repurchase a loser

30. Methodology for Testing Counterfactual Hypothesis Reconstruct portfolios from trading records. Count repurchases of stocks sold in previous 12 months that are down since being sold & repurchases of stocks sold in previous 12 months that are up since being sold. Count opportunities to repurchase stocks down since being sold & opportunities to repurchase stocks up since being sold. Calculate proportion of opportunities where a repurchase occurred for stocks “up since sold” & “down since sold.”

31. Counterfactual Reasoning Predicts That… # of stocks down since sale that were repurchased # of opportunities to repurchase stock down since sale. Should be greater than # of stocks up since sale that were repurchased # of opportunities to repurchase stock up since sale.

32. Naïve Learning for Large Discount Brokerage

33. Naïve Learning for Large Retail Brokerage

34. Counterfactual Reasoning for Large Discount Brokerage

35. Counterfactual Reasoning for Large Retail Brokerage

36. Interaction Effects: Stocks Initially Sold for a Gain (Taxable and Nontaxable Combined)

37. Interaction Effects: Stocks Initially Sold for a Loss (Taxable and Nontaxable Combined)

38. Alternative Explanation for the Naïve Learning Effect Investors may have superior information about stocks previously sold for a gain, and therefore profit from this behavior. However, our analysis found that investors do not benefit from that pattern, and are in fact marginally hurt by it.

39. Alternative Explanations for theCounterfactual Effect Investors believe in mean reversion and therefore buy stocks that have fallen in price. We saw no evidence for mean reversion expectations in the other trading data. Overall, investors are actually more likely to purchase stocks trending upwards. Investors correctly identify this behavior as profitable. Yet investors who bought stocks that went down since they sold them did not perform any better than the others.

40. What We Have Learned & “Deep Thoughts” We were right about naïve learning and counterfactual reasoning. (I was not alone in this irrational pattern.) This has a mild negative effect. (I have since stopped trading). Unclear if informing investors of this bias will help make them stop. (Its rather depressing to be reminded of your prior failures when you look at your portfolio). Given that these behavioral patterns do not improve profits, are they irrational? Perhaps not if they make investors feel better!!! Is it irrational to avoid going to a place with sad memories? Is it irrational to go back to a place with happy memories?

41. Future Research • : • Using controlled experiments with multiple independent and • dependent variables to investigate alternative explanations: • New Independent Variables: • * What if it was your money, but a money manager made the • decision? • * What if you are the money manager and its not your money? • New Dependent Variables: • Perceived likelihood of it being a good investment. • Explanations • Self vs. expectations for anonymous investors/managers. • Emotions as an intervening variable. • Answers to the question “why?”

42. THE END OF THE LAST PAPER OF OUR CONFERENCE! THANKS FOR STICKING IT OUT!!!