Investors' trading behavior in boom and bust markets

• Applicant: Professor Dr. Martin Weber
• Subject Area: Accounting and Finance
• Term: from 2019 to 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 427318789

Since the recent global financial crisis and its aftermath, macroeconomic cycles of financial markets are increasingly subject of major discussions. While the crisis itself gave rise to a call for greater consumer protection, little is known about the underlying drivers of how macroeconomic shocks affect investors’ beliefs and preferences (i.e. their risk aversion) and consequently, how macroeconomic shocks affect individual investors’ trading behavior. With our research proposal we aim to contribute to this ongoing debate. More precisely, we seek to answer two central questions. First, how is the trading of individual investors affected by macroeconomic cycles (i.e. boom and bust markets)? Second, are differences in trading behavior across boom and bust markets driven by a change in investors’ risk preferences (i.e. their inherent risk attitude) or by a change in beliefs (i.e. their estimates about future risk/returns)?A deeper understanding of how and why individual investors trade differently across market cycles is of practical relevance and may provide important policy implications. Especially in the light of recent consumer protection efforts, it is essential to learn more about the underlying drivers of investment behavior. An example is the Markets in Financial Instruments Directive (MiFID) which requires investment firms to elicit customers risk preferences. However, there are no guidelines about how and how often risk profiles should be evaluated. In essence, we expect to obtain insights about the time dynamics of investors’ beliefs and preferences. This, in turn, allows us to make suggestions about how to improve the effectiveness of consumer protection policies. To do so, we propose a three-folded approach, which combines empirical and experimental analyses. In our first working project (WP1), we aim to empirically investigate if and how investors’ selling behavior is different across macroeconomic cycles. In particular, we study how the disposition effect, i.e. investors tendency to sell winners too early and hold losers too long, changes in boom and bust periods. In the second working project (WP2), we analyze the drivers of investment behavior across market conditions. More precisely, we aim to test experimentally whether differences in how investors learn to form beliefs between boom and bust markets explain the investment behavior.In our third working project (WP3), we will complement previous analyses on selling behavior by empirical and experimental investigations on buying behavior across boom and bust markets. We will focus on three types of reinvestment decisions in the analysis.Overall, we aim to provide a holistic analysis on trading behavior in boom and bust markets. Therefore, we first analyze how selling as well as buying behavior differ across macroeconomic cycles, and then test drivers (preferences vs. beliefs) causing the observed behavior. Methodological-wise, we combine empirical and experimental analyses.

• DFG Programme: Research Grants