The Quant Research Team at www.empiritrage.com has drawn attention to a recent study by William Goetzmann, Dasol Kim, Alok Kumar and Qin Wang which shows that weather-based indicators of mood impact perceptions of mispricing and trading decisions of institutional investors.
According to Empiritrage analyst William N. Goetzmann, “It is interesting because it points out that weather may affect highly educated investors, and that it would be interesting to see how the temperature (as opposed to cloudiness) affects stock returns.”
“Weather-Induced Mood, Institutional Investors, and Stock Returns”
Though a number of studies have established an indirect relationship between investors’ mood and asset prices, there is relatively little information available on how weather, and therefore, moods, affect the whales in the market – institutional investors; these players serve a huge role in price formation.
According to the authors, this is a ‘first-of-its-kind’ study that examines the impact of weather, particularly the sky cloud coverage variable, on institutional trading and on individual stock returns.
Stock level barometers of investor moods
“Mood fluctuations can have a persistent effect on asset prices through their impact on cognitive processes, but directly identifying how these processes are affected by mood is difficult due to data limitations,” say the authors.
The researchers matched weather data at the zip code level with data on institutional investor perceptions on stock investments and studied ‘mispricing’ in both individual stocks and the DJIA index. A database of actual institutional trades is also examined for the impact of the weather on trading decisions. The authors also introduce innovative new stock-level measures (barometers?) of investor mood.
Findings: Overpricing on overcast days
The study found interestingly that on cloudy days institutions showed a higher tendency to believe that individual stocks, as well as the DJIA, were overpriced. Not surprisingly, the institutional investors were more likely to press sales on relatively cloudier days.
“The impact of weather patterns on perceptions of mispricing and trading activities is significant both statistically and economically. In particular, a one standard deviation change in cloud coverage generates close to 8% of the total sample variation in perceived DJIA overpricing,” say the authors.
Finally, the aforesaid stock-level mood indicators revealed that if investors were suffering the “weather-induced” blues, so to speak, this reflected negatively on daily stock returns.
The authors conclude that cloud coverage has a strong impact on the trading mentalities of institutional investors as well as on stock prices and that “the weather effect is pronounced amongst informed market participants and influences the price formation process.”