Episode 28: Terry Odean
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Financial Behavior and Psychological Biases: Lessons from the Accidental Economist
Do individual traders and institutional investors suffer from psychological bias? This episode features an interview with Terry Odean, Rudd Family Foundation Professor and Chair of the Finance Group at the Haas School of Business at the University of California, Berkeley.
He shares his journey from dropping out of a seminary to hitchhiking in Afghanistan, driving a cab in the 1970s, to starting his own statistical software company. Discover what Nobel economics laureate, Daniel Kahneman, has to do with career change and ending up in behavioral finance.
His findings on the difference in buying and investing behaviors between institutional and individual investors. Together with host Greg La Blanc, he unpacks the investment data he gathered from Taiwan. He offers well-founded insights into investing data before, during, and after the war and through the dot com bubble in 1998-2000.
Tune in till the end as he briefly touches on some of his work related to the disposition effect and a recent paper he wrote about the Robinhood app and the GameStop fiasco in 2020.
Episode Quotes:
What drew you to study individual investors?
"I thought institutional investors, most of them are human. They have human biases. However, they've had more opportunities to learn. And, I didn't know how much learning had or hadn't taken place, but I thought, well, individuals are. Far less likely to have had the opportunity to learn that they are behaving suboptimally, that their biases are causing them to make mistakes. The other reason that I wanted to look at individual investors? The other reason that I wanted to look at individual investors? This is because I initially wanted to avoid conflating behavioral biases and agency issues. And what I mean by that is those individual investors, especially at discount brokerage firms. And I got my initial data sets from a discount. Brokerage firms are making decisions for themselves at the time. This firm did not provide financial advisors and advice that's changed. But when I got my data set, individuals made their own decisions. It was relatively straightforward to say this is a person making a financial decision that will directly affect their wealth."
What drives the market upwards?
"Another thing that drives markets up is when more and more people put their money in the market. And one of the things that cause people to put their money in the market is that the market is going up...It has probably be tied to a story or something. And then it tends to snowball a little bit, as they say, use of margin, the use of margin was way up in 1999. I believe probably high at the moment. The use of margin by individual investors, the willingness to borrow money. So it's to buy more stock. The stock market is a secondary market. It's generally people trading stocks that already exist. If you want to buy it, a stock, you have to offer someone who already owns it enough money. They're willing to sell it. If they're the one who wants to sell, they have to sell it to you at a price where you're willing to buy. If there are a lot of people who want to buy and the people who currently own are content, then that starts to drive the price up because the buyers have to bid up the price to get the people who want it to sell."
Thoughts on taking risks and stock markets as a substitute for risk-taking and lottery:
"And you're right in the study that I mentioned before where we looked at all Taiwanese investors. We had a little, almost an aside in that paper. We took a look at when Taiwan instituted a national lottery. And that's not to say that you couldn't gamble in Taiwan before the national lottery. There were ways to gamble, but they instituted the national lottery. And we have a little model of expected, trading on the Taiwanese stock exchange and trading fell 25% when the lottery came in. And what we thought was going on is a lot of these people are trading, and turnover was very high. The individual investor turnover would be three, four, or 500%. That means that every stock gets bought. Say if it's 500%, every stock gets bought and sold. Every share of every stock, on average, gets bought and sold five times a year. So there is clearly a lot of speculation going on, and we thought, well, a bunch of people just said, oh, this week, this month, I'm going to try the lottery instead of gambling on the stock market."
People at all levels are susceptible to psychological biases to some degree, and will it be helpful to do a psychological hygiene process on a regular basis to alert themselves to any of the biases that they may be succumbing to?
"Professional investors, they're also human. And they have many of the same biases. I think they have had more learning opportunities. So as you say, hedge fund managers consciously try to recognize and deal with their own biases, be aware of them, and watch out for them. And certainly, that helps. So knowing that you have these biases is useful, but it doesn't instantly stop you from being influenced by them. I think institutional investors sometimes come up with checks, balances, protocols. For example, there's something called the disposition effect. And that was for the tendency of people to hold onto their losses and sell their winning investments. So things they had done well."
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