Investors' trading behavior in boom and bust markets
Final Report Abstract
The project investigates key aspects of investor behavior across economic expansion and contraction phases. It examines how investors adjust their decisions as economic conditions shift from boom to bust and the role that psychological factors (behavioral biases) play in this process. Paper 1 addresses the disposition effect - the tendency of investors to realize gains more readily than to cut losses. While previous studies have predominantly focused on boom periods, our study analyzes individual trading data of German investors over several market cycles (2001–2015). Our findings indicate that the disposition effect is significantly more pronounced during downturns. Specifically, investors realize gains approximately 26% more frequently during crises, suggesting that altered risk preferences and adjustments in investor beliefs are at work. In Paper 2, we broaden the perspective by questioning the assumption of rational expectations and examining the influence of systematic biases in investors’ market expectations. The experimental evidence reveals that investors’ risk tolerance adjusts asymmetrically across different market phases. During boom periods, expectations are updated more cautiously, whereas, in recessions, there is a more rapid adjustment in response to negative market signals. These insights provide important implications for modern asset pricing models and illustrate how subjective perceptions and expectations shape the dynamics of risk tolerance. Paper 3 focuses on the behavior of retail investors with respect to dividend payments. Contrary to the traditional notion that households tend to consume dividends rather than reinvest them, our data from a German bank show that approximately 80% of dividends are reinvested by institutional clients - while only 12% is allocated to consumption. It is noteworthy that there is often a time lag between the receipt of dividends and their reinvestment, as the amounts are initially held as credits in accounts. We examine different payout modalities, such as deposits into brokerage or checking accounts versus payments by check, and demonstrate that technical adjustments - such as the increased transfer of funds to brokerage accounts - significantly influence investment decisions. The project provides valuable insights into the interplay between economic cycles, risk preferences, and investment decisions. Our work is relevant as it contributes to understanding how underlying macroeconomic shocks affect investor behavior and risk tolerance. Our findings are relevant for both academia and the banking sector including financial advisers.
Publications
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The Disposition Effect in Boom and Bust Markets. SSRN Electronic Journal.
Bernard, Sabine; Loos, Benjamin & Weber, Martin
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Reinvesting Dividends. SSRN Electronic Journal.
Müller-Dethard, Jan; Reinhardt, Niklas & Weber, Martin
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Risk-Taking and Asymmetric Learning in Boom and Bust Markets. Review of Finance, 27(5), 1743-1779.
Kieren, Pascal; Müller-Dethard, Jan & Weber, Martin
