Abstract: Most research on heuristics and biases in financial decision-making comes from data from non-experts, such as retail investors who hold modest portfolios. We use a unique data set to show that financial market experts -- institutional investors with portfolios averaging $ 573 million -- exhibit costly, systematic biases. A striking finding emerges: while investors display clear skill in buying, their selling decisions underperform substantially -- even relative to strategies involving no skill such as random selling. We present evidence for limited attention as the driver of this discrepancy, with investors devoting more attentional resources to buy decisions than sell decisions. A salience heuristic explains much of the underperformance in selling: investors are prone to sell assets with extreme returns across all specifications. This strategy is a mistake, resulting in substantial losses relative to randomly selling assets to raise the same amount of money. In contrast to selling decisions, the salience heuristic does not appear to drive buying decisions, which are not affected by prior returns.
Research performed with Klakow Akepanidtaworn, Rick Di Mascio and Lawrence Schmidt.
Finance Seminars at Caltech are funded through the generous support of The Ronald and Maxine Linde Institute of Economic and Management Sciences (lindeinstitute.caltech.edu).