Baseball, Individual Investors And Behavioral Finance

Baseball, Individual Investors And Behavioral Finance

When presenting their key non-forecasts for 2013, the RBC Capital Markets analysts found some interesting facts about how some human conditions affect decision making in baseball, and how the same behavior is reflected in the investment world. Here are the little snippets they found helpful when making investment decisions.

Baseball or Investment, People Avoid Making Controversial or Tough Decisions

There have long been suspicions about the impact of umpires on a game’s output. Though umpires are accurate 85 percent of times in calling balls and strikes, they do show a strong bias based on the situation. The analysts reveal that umpires generally avoid calling a 4th ball or a 3rd strike. And this ‘avoiding’ behavior is more prominent in case of strong players. Another bias, in high pressure situations they call strikes in favor of the home team.

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Tough or Controversial Decisions

How Meaningless Performance Thresholds Affect Investment Behavior

Players with an average of .300 are on the top of the league. You might have noticed that during the final at-bat season, the players with .300 simply try to get replaced by a pinch hitter or walk. On the other hand, .299 hitters have no risk of striking out, so they swing freely to get to .300 mark.

A similar, immaterial hit can have profound effect on a stock’s market valuation. For example, quarterly earnings surprises immediately boost a firm’s stock prices. Companies always put forth a conservative guidance just to deliver positive surprises, even if they beat the guidance by some insignificant pennies.

Performance Thresholds

Perhaps investors should focus more on the firm’s long-term prospects instead of quarterly earnings forecasts.

More Information Doesn’t Always Mean Greater Performance

Analysts say that money managers who spend more time gathering investment information are likely to trade more and take more risks. And slowly they stop delegating portfolio decisions to others. Various studies have revealed that the amount of information collected strongly boosts confidence in decision making, but negatively affects the risk-adjusted portfolio performance.

Fitting The Data To The Story, Not Vice-versa

Most investors with excess information and overconfidence tend to fit their findings to a story rather than deriving a story from their data. That is why they sometimes miss the important variables. And their attempts to make the story appear real sometimes leads to worthless information.

RBC analysts found the relevance between the Google searches for the keyword “Kiss the rain” and price performance of S&P 500. This keyword, whatever it means, has maintained a 12-month lead over the S&P 500 (INDEXSP:.INX). If people track this story, it points to a 20-30 percent decline in the share prices this year.

Fitting the Data

Finally, the analysts believe that their team Blue Jays will win the 2013 World Series. The Torontonians are feeling extra festive this season. The analysts may be biased just like baseball umpires. But Vegas bookies are on their side pegging the Jays as the favorites with 8/1 odds.

But remember, bookies are also subjected to overconfidence.

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