All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors

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1 All ha Gliers: The Effec of Aenion and News on he Buying Behavior of Individual and Insiuional Invesors Brad M. Barber Terrance Odean * January 005 * Barber is a he Graduae School of Managemen, Universiy of California, Davis. Odean is a he Haas School of Business, Universiy of California, Berkeley. We appreciae he commens of Jonahan Berk, David Blake, Ken French, Simon Gervais, John Griffin, Andrew Karolyi, Sendhil Mullainahan, Mark Rubinsein, Bre Trueman and seminar paricipans a Arizona Sae Universiy, he Behavioral Decision Research in Managemen Conference, he Universiy of California, Berkeley, he Universiy of California, Irvine, he Copenhagen Business School, Cornell Universiy, Emory, HEC, Norwegian School of Economics and Business Adminisraion, Ohio Sae Universiy, Osaka Universiy, he Q Group, he Sanford Insiue for Theoreical Economics, he Sockholm School of Economics, he Universiy of Tilburg, Vanderbil, he Wharon School, he CEPR/JFI symposium a INSEAD, Mellon Capial Managemen, he Naional Bureau of Economic Research, and he Risk Percepions and Capial Markes Conference a Norhwesern Universiy. We are graeful o he Plexus Group, o BARRA, and o he reail broker and discoun brokers who provided us wih he daa for his sudy and o he Insiue for Quaniaive Research and he Naional Science Foundaion (gran #SES ) for financial suppor. Shane Shepherd, Michael Foser, and Michael Bowers provided valuable research assisance. All errors are our own. Brad Barber can be reached a (530) or Terrance Odean can be reached a (510) or

2 Absrac We es and confirm he hypohesis ha individual invesors are ne buyers of aeniongrabbing socks, e.g., socks in he news, socks experiencing high abnormal rading volume, and socks wih exreme one day reurns. Aenion-based buying resuls from he difficuly ha invesors have searching he housands of socks hey can poenially buy. Individual invesors don face he same search problem when selling, because hey end o sell only a small subse of all socks hose hey already own. Socks bough by individual invesors on high-aenion days end o subsequenly underperform socks sold by hose invesors.

3 Aenion is a scarce resource. When here are many alernaives, choices ha arac aenion are more likely o be chosen. If he salien aribues of a choice are criical o our uiliy, aenion serves us well. If no, aenion may lead o sub-opimal choices. In his paper, we es he proposiion ha individual invesors are more likely o buy raher han sell hose socks ha cach heir aenion. We posi ha his is so because aenion affecs buying, where invesors search across housands of socks, more han selling, where invesors generally choose only from he few socks ha hey own. While each invesor does no buy every single sock ha grabs his aenion, individual invesors are more likely o buy aenion-grabbing socks han o sell hem. We provide srong evidence ha his is he case. In heory, he collecive endency o buy more aggressively han sell aenion-grabbing socks should lead o poor subsequen reurns; we presen empirical evidence ha suppors his predicion. In conras o our findings, many heoreical models of financial markes rea buying and selling as wo sides of he same coin. Informed invesors observe he same signal wheher hey are deciding o buy or o sell. They are equally likely o sell securiies wih negaive signals as hey are o buy hose wih posiive signals. Uninformed noise raders are equally likely o make random purchases or random sales. In formal models, he decisions o buy and o sell ofen differ only by a minus sign. For acual invesors, he decisions o buy and o sell are fundamenally differen. When buying a sock, invesors are faced wih a formidable search problem. There are over 7,000 U. S. common socks from which o choose. Human beings have bounded raionaliy. There are cogniive and emporal limis o how much informaion we can process. We are generally no able o rank hundreds, much less housands, of alernaives. Doing so is even more difficul when he alernaives differ on muliple dimensions. One way o make he search for socks o purchase more manageable is o limi he choice se. I is far easier, for example, o choose among 10 alernaives han 100. Odean (1999) proposes ha invesors manage he problem of choosing among housands of possible sock purchases by limiing heir search o socks ha have recenly For example, see he well-cied models of Grossman and Sigliz (1980) and Kyle (1985). 1

4 caugh heir aenion. Invesors do no buy all socks ha cach heir aenion; however, for he mos par, hey only buy socks ha do so. Which aenion-grabbing socks invesors buy will depend upon heir personal preferences. Conrarian invesors, for example, will end o buy ou of-favor socks ha cach heir eye, while momenum invesors will chase recen performers. In heory, invesors face he same search problem when selling as when buying. In pracice, wo facors miigae he search problem for individual invesors when hey wan o sell. Firs, mos individual invesors hold relaively few common socks in heir porfolio. 3 Second, mos individual invesors only sell socks ha hey already own; ha is, hey don sell shor. 4 Thus, invesors can, one by one, consider he meris boh economic and emoional of selling each sock hey own. Raional invesors are likely o sell heir pas losers, hereby posponing axes; behaviorally moivaed invesors are likely o sell pas winners, hereby posponing he regre associaed wih realizing a loss (see Saman and Shefrin, 1985). Thus, o a large exen, individual invesors are concerned abou he fuure reurns of he socks hey buy bu he pas reurns of he socks hey sell. Our argumen ha aenion is a major facor deermining he socks individual invesors buy, bu no hose hey sell, does no apply wih equal force o insiuional invesors. There are wo reasons for his: 1) Unlike individual invesors, insiuions do ofen face a significan search problem when selling. Insiuions also face many choices when purchasing, bu, unlike individuals, hey also face many choices when selling. Insiuional invesors, such as hedge funds, rouinely sell shor. For hese invesors, he search se for purchases and sales is idenical. Even insiuions ha do no sell shor face far more choices when selling han do mos individuals, simply because hey own much larger porfolios han do mos individuals. ) Aenion is no as scarce a resource for insiuional invesors as i is for individuals. Insiuional invesors devoe more ime o searching for socks o buy and sell han do mos individuals. Insiuions use compuers o narrow heir search. They may limi heir search o 3 On average during our sample period, he mean household in our large discoun brokerage daase held 4.3 socks worh $47,334; he median household held.61 socks worh $16, percen of posiions are shor posiions for he invesors in he large discoun brokerage daase ha we describe in Secion II. When he posiions are weighed by heir value, 0.78 percen are shor.

5 socks in a paricular secor (e.g., bioech) or meeing specific crieria (e.g., low price-oearnings raio) hus reducing aenion demands. While individuals, oo, can use compuers or pre-selecion crieria, on average, hey are less likely o do so. In his paper, we es he hypoheses ha (1) he buying behavior of individual invesors is more heavily influenced by aenion han is heir selling behavior and ha () he buying behavior of individual invesors is more heavily influenced by aenion han is he buying behavior of professional invesors. We also develop a model based on he assumpion ha aenion influences buying more han selling and we es he asse pricing predicions of our model. These predicions are (1) ha socks heavily purchased by aenion-based invesors will subsequenly underperform socks heavily sold by hose invesors and () ha his underperformance will be greaes following periods of high aenion. How can we measure he exen o which a sock grabs invesors aenion? A direc measure would be o go back in ime and, each day, quesion he hundreds of housands of invesors in our daases as o which socks hey hough abou ha day. Since we canno measure he daily aenion paid o socks direcly, we do so indirecly. We focus on hree observable measures ha are likely o be associaed wih aenion grabbing evens: news, unusual rading volume, and exreme reurns. While none of hese measures is a perfec proxy for aenion, all hree are useful. An aenion grabbing even is likely o be repored in he news. Invesors aenion could be araced hrough oher means, such as cha rooms or word of mouh, bu an even ha aracs he aenion of many invesors is usually newsworhy. However, news sories are no all creaed equal. Major nework reporing of he indicmen of a Forune 500 CEO will arac he aenion of millions of invesors while a rouine company press release may be noiced by few. Our hisorical news daa from he Dow Jones News Service do no ell us how many invesors read each sory nor do hey rank each sory s imporance. We infer he reach and impac of evens by observing heir effecs on rading volume and reurns. Trading volume in he firm s sock is likely o be greaer han usual when significan news abou a firm reaches many invesors. Of course, his won necessarily be he case. 3

6 Possibly invesors will recognize his news o be irrelevan o he firm s fuure earnings and no rade or invesors will all inerpre he news similarly and no rade. Bu significan news will ofen affec invesors beliefs and porfolio goals heerogeneously, resuling in greaer han usual rading. If unusually many invesors rade a sock i is nearly auological ha unusually many invesors are paying aenion o ha sock. Bu high abnormal rading volume could also be driven by he liquidiy or informaion based rades of a few large invesors. This is especially rue for small capializaion socks wih low average rading volume. While large rades by a few invesors may add noise o our calculaions, hey are unlikely o be driving our resuls which are as srong, or sronger, for large capializaion socks as for small. Imporan news abou a firm ofen resuls in significan posiive or negaive reurns. Some news may be difficul o inerpre and resul in unusually acive rading wihou much price change. Bu when here is a big price move i is likely ha whaever caused he move also caugh invesors aenion. And even when price is responding o privae, no public, informaion, significan reurns will ofen, in and of hemselves, arac aenion. Our hree proxies for wheher invesors were paying aenion o a firm are: 1) a sock s abnormal daily rading volume, ) he sock s (previous) one day reurn 5, and 3) wheher he firm appeared in ha day s news. We examine he buying and selling behavior associaed wih aenion for four samples of invesors: invesors wih accouns a a large discoun brokerage, invesors a a smaller discoun brokerage firm ha adverises is rade execuion qualiy, invesors wih accouns a a large reail brokerage, and professional money managers. Our predicion is ha individual invesors will acively buy socks on high-aenion days. We are no predicing ha hey will acively rade on high-aenion days ha would be nearly auological when we use abnormal rading volume as a proxy for aenion bu, raher, ha hey will be ne buyers. 4

7 For every buyer here mus be a seller. Therefore, on days when aenion-driven invesors are buying, some invesors, whose purchases are less dependen on aenion, mus be selling. We anicipae herefore ha professional invesors as a whole (inclusive of markemakers) will exhibi a lower endency o buy, raher han sell, on high aenion days and a reverse endency on low aenion days. (Excepions will arise when he even driving aenion coincides wih he purchase crieria ha a paricular professional invesor is pursuing.) As prediced, individual invesors end o be ne buyers on high aenion days. For example, invesors a he large discoun brokerage make nearly wice as many purchases as sales of socks experiencing unusually high rading volume (e.g, he highes five percen) 6 and nearly wice as many purchases as sales of socks wih an exremely poor reurn (lowes 5 percen) he previous day. The buying behavior of he professionals is leas influenced by aenion. The plan of he paper is as follows. We discuss relaed research in secion I. We describe he four daases in secion II, and our soring mehodology in secion III. In Secion IV, we briefly describe our model of aenion-based buying which we presen in he Appendix. We presen evidence of aenion-based buying in secion V, and discuss an alernaive hypohesis in secion VI. In VII, we es he asse pricing implicaions of our model and we conclude in secion VIII. I. Relaed Research A number of recen sudies examine invesor rading decisions. Odean (1998a) finds ha, as prediced by Shefrin and Saman (1985), individual invesors exhibi a disposiion effec invesors end o sell heir winning socks and hold on o heir losers. Boh individual and professional invesors have been found o behave similarly wih several ypes of asses 5 We use previous day s reurn, raher han same day reurn because of poenial endogeneiy problems. While we argue ha exreme price moves will arac buyers, clearly buyers could also cause price moves. Our resuls are qualiaively similar when we use same day reurns as a proxy for aenion. 5

8 including real esae (Genesove and Mayer, 001), company sock opions (Heah, Huddar, and Lang, 1999), and fuures (Heisler, 1994; Locke and Mann, 1999) (also see Shapira and Venezia, 1998). I is well-documened ha volume increases on days wih informaion releases or large price moves (Bamber, Barron, and Sober (1997); Karpoff (1987)). For example, when Maria Bariromo menions a sock during he Midday Call on CNBC, volume in he sock increases nearly fivefold (on average) in he minues following he menion (Busse and Green (00)). Ye, for every buyer here is a seller. In general, hese sudies do no invesigae who is buying and who is selling, which is he focus of our analysis. One excepion is Lee (199). He examines rading aciviy around earnings announcemens for 30 socks over a one-year period. He finds ha individual invesors hose who place marke orders of less han $10,000 are ne buyers subsequen o boh posiive and negaive earnings surprises. Hirshleifer, Myers, Myers, and Teoh (00) also documen ha individual invesors are ne buyers following boh posiive and negaive earnings surprises. Lee (199) conjecures ha news may arac invesors aenion or, alernaively, ha reail brokers who end o make more buy han sell recommendaions may rouinely conac heir cliens around he ime of earnings announcemens. Odean (1999) examines rading records of invesors a a large discoun brokerage firm. He finds ha, on average, he socks hese invesors buy underperform hose hey sell, even before considering ransacions coss. He observes ha hese invesors buy socks ha have experienced greaer absolue price changes over he previous wo years han he socks hey sell. He poins ou he dispariy beween buying and selling decisions for individual invesors and he search problem hey face when choosing from among housands of socks. He suggess ha many invesors limi heir search o socks ha have recenly capured heir aenion, wih conrarians buying previous losers and rend chasers buying previous winners. 6 Looking a all common sock ransacions, invesors a his brokerage make slighly more purchases (1,08,107) han sales (887,594). 6

9 Of course, fully raional invesors will recognize he limiaions of predominanly buying socks ha cach heir aenion. They will realize ha he informaion associaed wih an aenion-grabbing even may already be impounded ino price (since he even has undoubedly been noiced by ohers), ha he aenion-grabbing even may no be relevan o fuure performance, and ha non-aenion-grabbing socks may presen beer purchase opporuniies. Odean (1998b) argues ha many invesors rade oo much because hey are overconfiden abou he qualiy of heir informaion. Such invesors may overvalue he imporance of evens ha cach heir aenion, hus leading hem o rade sub-opimally. Odean (1999) and Barber and Odean (000, 001, 00) find ha, on average, self-direced individual invesors do rade sub-opimally, lowering heir expeced reurns hrough excessive rading. Meron (1987) noes ha individual invesors end o hold only a few differen common socks in heir porfolios. He poins ou ha gahering informaion on socks requires resources and suggess ha invesors conserve hese resources by acively following only a few socks. If invesors behave his way, hey will buy and sell only hose socks ha hey acively follow. They will no impulsively buy socks ha hey do no follow simply because hose socks happen o cach heir aenion. Thus heir purchases will no be biased oward aeniongrabbing socks. In recen work, Seasholes and Wu (004) es our heory in a unique ou-of-sample seing. They observe ha on he Shanghai Sock Exchange individual invesors are ne buyers he day afer a sock his an upper price limi. Seasholes and Wu s inerpreaion of his behavior is ha he aenion of individual invesors is araced by he even of hiing a price limi and, consisen wih our heory, individuals become ne buyers of socks ha cach heir aenion. Also consisen wih our heory, Seasholes and Wu documen a ransiory impac on prices wih reversion o pre-even levels wihin en rading days. Finally, hey idenify a small group of professional invesors who profi a he expense of individual invesors by anicipaing his emporary surge in price and demand. 7

10 II. Daa In his sudy, we analyze invesor rading daa drawn from four sources: a large discoun brokerage, a small discoun brokerage, a large full-service brokerage, and he Plexus Group a consuling firm ha racks he rading of professional money managers for insiuional cliens. The firs daase for his research was provided by a large discoun brokerage firm. I includes rading and posiion records for he invesmens of 78,000 households from January 1991 hrough December The daa include all accouns opened by each household a his discoun brokerage firm. Sampled households were required o have an open accoun wih he discoun brokerage firm during Roughly half of he accouns in our analysis were opened prior o 1987, while half were opened beween 1987 and In his research, we focus on invesors common sock purchases and sales. We exclude from he curren analysis invesmens in muual funds (boh open- and closed-end), American deposiory receips (ADRs), warrans, and opions. Of he 78,000 households sampled from he large discoun brokerage, 66,465 had posiions in common socks during a leas one monh; he remaining accouns held eiher cash or invesmens in oher han individual common socks. Roughly 60 percen of he marke value in hese households accouns was held in common socks. There were over 3 million rades in all securiies; common socks accouned for slighly more han 60 percen of all rades. During our sample period, he average household held 4.3 socks worh $47,334, hough each of hese figures is posiively skewed. The median household held.61 socks worh $16,10. In December 1996, hese households held more han $4.5 billion in common sock. There were slighly more purchases (1,08,107) han sales (887,594) during our sample period, hough he average value of socks sold ($13,707) was slighly higher han he value of socks purchased ($11,05). As a resul, he aggregae values of purchases and sales were roughly equal ($1.1 and $1. billion, respecively). The average rade was ransaced a a price of $31 per share. 7 Posiion records are hrough December 1996; rading records are hrough November See Barber and Odean (000) for a more compee descripion of hese daa. 8

11 The value of rades and he ransacion price of rades are posiively skewed; he medians for boh purchases and sales are subsanially less han he mean values. Our second daa se conains informaion from a smaller discoun brokerage firm. This firm emphasizes high qualiy rade execuion in is markeing and is likely o appeal o more sophisicaed, more acive, invesors. The daa include daily rading records from January 1996 hrough June 15, Accouns classified by he brokerage firm as professionals are excluded from our analysis. 8 The daa include 14,667 accouns for individual invesors who make 14,73 purchases wih a mean value of $55,077 and 198,541 sales wih a mean value of $55,999. The hird daa se conains informaion from a large reail brokerage firm on he invesmens of households for he 30 monhs ending in June These daa include daily rading records. Using clien ownership codes supplied by he brokerage firm, we limi our analysis o he 665,533 invesors wih non-discreionary accouns (i.e., accouns classified as individual, join enans wih righs of survival, or cusodian for minor) wih a leas one common sock rade during our sample period. During his period hese accouns execued over 10 million rades. We resric our analysis o heir common sock rades: 3,974,998 purchases wih a mean value of $15,09 and 3,19,99 sales wih a mean value of $1,169. Our individual invesor daa include ens of housands of invesors a boh discoun and reail brokerages. These daa are likely o be fairly represenaive of U.S. individual invesors. Our insiuional daa, however, are more illusraive han represenaive of insiuional invesors. The daa were compiled by he Plexus Group as par of heir advisory services for heir insiuional cliens. The daa include daily rading records for 43 insiuional money managers and span he period January 1993 hrough March No all managers are in he sample for he enire period. In addiion o documening compleed purchases and sales, he daa also repor he dae and ime a which he manager decided o make a purchase or sale. In 8 We analyze he accouns of professional invesors separaely. There are, however, no enough daa o achieve saisically significan resuls. 9

12 he daa, hese money managers are classified as momenum, value, and diversified. 9 During our sample period, he eigheen momenum managers make 789,779 purchases wih a mean value of $886,346 and 617,915 sales wih a mean value of $896,165; he eleven value managers make 409,53 purchases wih a mean value of $500,949 and 350,00 sales wih a mean value of $564,69; he foureen diversified managers make 31,457 purchases wih a mean value of $450,474 and 0,147 sales wih a mean value of $537,947. III. Sor Mehodology A. Volume Sors On he days when a sock experiences abnormally heavy volume, i is likely ha invesors are paying more aenion o i han usual. We wish o es he exen o which he endency o buy socks increases on days of unusually high rading volume for each of our four invesor groups (large discoun, reail, small discoun, and professional). Firs we mus sor socks on he basis of abnormal rading volume. We do so by calculaing for each sock on each rading day he raio of he sock s rading volume ha day o is average rading volume over he previous one year (i.e., 5 rading days). Thus, we define abnormal rading volume for sock i on day, where Vi AVi o be AV V V i i = (1) i is he dollar volume for sock i raded on day as repored in he Cener for Research in Securiy Prices (CRSP) daily sock reurn files for New York Sock Exchange (NYSE), American Sock Exchange (ASE), and NASDAQ socks and 1 Vi Vid =. () d= 5 5 Each day we sor socks ino deciles on he basis of ha day s abnormal rading volume. We furher subdivide he decile of socks wih he greaes abnormal rading volume ino wo vingiles (i.e., five percen pariions). Then, for each of our invesor ypes, we sum 9 Keim and Madhavan (1995, 1997, and 1998) analyze earlier daa from he Plexus Group. They classify managers as echnical, value, and index. Based on conversaions wih he Plexus Group, we believe ha hese classificaion correspond o our momenum, value, and diversified classificaions. 10

13 he buys (B) and sells of socks (S) in each volume pariion on day and calculae buy-sell imbalance for purchases and sales execued ha day as: BSI np NB np i i= 1 i= 1 p = np np NB + i i= 1 i= 1 NS NS where n p is he number of socks in pariion p on day, i i NB i (3) he number of purchases of sock i on day, and NS i he number of sales of sock i on day. We calculae he ime series mean of he daily buy-sell imbalance (BSI p ) for he days ha we have rading daa for each invesor ype. Noe ha hroughou he paper our measure of buy-sell imbalance considers only execued rades; limi orders are couned if and when hey execue. If here are fewer han five rades in a pariion on a paricular day, ha day is excluded from he ime series average for ha pariion. We also calculae buy-sell imbalances based on he value raher han number of rades by subsiuing in he value of he sock i bough (or sold) on day for NB i (or NS i ) in equaion 3. Noe ha while oal buys and sells increase as volume increases, on a value weighed basis, aggregae buys and sells will increase equally. Thus aggregae value weighed (execued) buy-sell imbalance remains zero as abnormal volume increases, and how he buysell imbalance of a paricular invesor group changes wih volume is an empirical quesion. In summary, for each pariion and invesor group combinaion, we consruc a imeseries of daily buy-sell imbalance. Our inferences are based on he mean and sandard deviaion of he ime series. We calculae he sandard deviaion of he ime series using a Newey-Wes correcion for serial dependence. B. Reurn Sors Invesors are likely o noice when socks have exreme one day reurns. Such reurns, wheher posiive or negaive, will ofen be associaed wih news abou he firm. The news driving exreme performance will cach he aenion of some invesors, while he exreme reurn iself will cach he aenion of ohers. Even in he absence of oher informaion, exreme reurns can become news hemselves. The Wall Sree Journal and oher media rouinely repor he previous day s big gainers and losers (subjec o cerain price crieria). If 11

14 big price changes cach invesors aenion, hen we expec hose invesors whose buying behavior is mos influenced by aenion will end o purchase in response o price changes boh posiive and negaive. To es he exen o which each of our four invesor groups are ne purchasers of socks in response o large price moves, we sor socks based on one day reurns and hen calculae average buy-sell imbalances for he following day. We calculae imbalances for he day following he exreme reurns, raher han he same day as exreme reurns, for wo reasons. Firsly, many invesors may learn of or reac o he exreme reurn only afer he marke closes; heir firs opporuniy o respond will be he nex rading day. Secondly, buysell imbalances could cause conemporaneous price changes. Thus, examining buy-sell imbalances subsequen o reurns, removes a poenial endogeneiy problem. 10 Our resuls are qualiaively similar when we sor on same day reurns. Each day (-1) we sor all socks for which reurns are repored in he CRSP NYSE/AMEX/NASDAQ daily reurns file ino en deciles based on he one day reurn. We furher spli decile one (lowes reurns) and decile en (highes reurns) ino wo vingiles. We hen calculae he ime series mean of he daily buy-sell imbalance for each pariion on he day following he reurn sor. This calculaion is analogous o ha for our sors based on abnormal volume Endogeneiy does no pose he same problem for news and abnormal volume sors. I is unlikely ha he percenage of individual invesors (or insiuional invesors ) rades ha is purchases causes conemporaneous news sories. Nor does he percenage of individual invesors (or insiuional invesors ) rades ha is purchases cause abnormal rading volume. 11 Typically a significan number of socks have a reurn equal o zero on day -1. These socks may span more han one pariion. Therefore, before calculaing he buy-sell imbalance for each pariion, we firs calculae he average number (and value) of purchases and sales of socks wih reurns of zero on day -1; in subsequen calculaions, we use his average number (and value) of purchases and sales for zero reurn socks. The average number of purchases on day of a sock wih a reurn of zero on day -1 is S0 NBs s= 1 S, 0 where S o is he number of socks wih zero reurn on day -1. There is an analogous calculaion for sales. where NB is he number of imes sock s was purchased by invesors in he daase on day and s number of socks wih a reurn of zero on day -1. Similar calculaions are done o deermine he average number of sales and he average value of purchases and sales for socks wih a reurn of zero on day -1. S 0 is he 1

15 C. News Sors Firms ha are in he news are more likely o cach invesors aenion han hose ha are no. Our news daase is he daily news feed from Dow Jones News Service. The Dow Jones news feed includes he icker symbols for each firm menioned in each aricle We pariion socks ino hose for which here is a news sory ha day and hose wih no news On an average day, our daase records no news for 91% of he firms in he CRSP daabase.. The daa begin in Due o how he daa were colleced and sored some days are missing from he daa.. We calculae buy-sell imbalances for each firm s sock as described in Secion IIIa. News is a primary mechanism for caching invesors aenion. Noneheless, our empirical ess based on news coverage lack he power of our volume and reurn sors because we are unable o accuraely measure he inensiy or salience of news coverage, and we are missing news coverage daa for much of our sample period. IV. Resuls A. Volume Sors Trading volume is one indicaor of he aenion a sock is receiving. Table I presens buy-sell imbalances for socks sored on he curren day s abnormal rading volume. Buy-sell imbalance is repored for invesors a a large discoun brokerage, a large reail brokerage, and a small discoun brokerage and for insiuional money managers following momenum, value, and diversified sraegies. Invesors a he large discoun brokerage display he greaes amoun of aenion-based buying. When imbalance is calculaed by number of rades (column wo), buy-sell imbalance is negaive percen for socks in he lowes volume decile. For socks in he highes volume vingile, buy-sell imbalance is posiive 9.5 percen more. Buy-sell imbalance for hese invesors rises monoonically wih rading volume. When imbalance is calculaed by value of rades (column hree), buy-sell imbalance is negaive 16.8 percen for socks in he lowes volume decile. For socks in he highes volume vingile, buy-sell imbalance is posiive percen. Again, buy-sell imbalance increases nearly monoonically wih rading volume. Looking a he fourh hrough sevenh columns of Table 1, we see ha he ne buying behavior of invesors a he large reail broker and he small discoun brokerage behaves similarly o ha of invesors a he large discoun brokerage. 13

16 Our principal objecive is o undersand how aenion affecs he purchase decisions of all invesors. Calculaing buy-sell imbalance by he value of rades has he advanage of offering a beer gauge of he economic imporance of our observaions, bu he disadvanage of overweighing he decisions of wealhier invesors. In rying o undersand invesors decision processes, calculaing buy-sell imbalance by number of rades may be mos appropriae. In he appendix, we presen a heoreical model as in Kyle (1985). The key assumpion of our model is invesors engage in aenion-based buying. The main purpose of he model is o provide a rigorous derivaion of he asse pricing implicaions of aenion-based buying, which we discuss laer in he paper. Here we wan o emphasize ha he key assumpion of our heoreical model is srongly suppored by empirical evidence. Figure 1a plos average buy-sell imbalance condiional on rading volume for 100,000 simulaions based on our heoreical model. Figure a plos he buy-sell imbalance based on number of rades for invesors a he large discoun brokerage, he large reail brokerage, and he small discoun brokerage. Noe ha he simulaed and he empirical plos are boh upward sloping. The simulaion serves o illusrae ha our empirical resuls are consisen wih wha we find in a simple model when invesors are assumed o engage in aenion-based buying. The las six columns of Table 1 and Figure b presen he buy-sell imbalances of insiuional money managers for socks sored on he curren day s abnormal rading volume. Overall, hese insiuional invesors exhibi he opposie endency of he individual invesors, heir buy-sell imbalance is greaer on low volume days han high volume days. This is paricularly rue for value managers who are aggressive ne buyers on days of low abnormal rading volume. B. Reurns Sors Invesors are likely o ake noice when socks exhibi exreme price moves. Such reurns, wheher posiive or negaive, will ofen be associaed wih new informaion abou he firm. Table II and Figures 3a and 3b presen buy-sell imbalances for socks sored on he previous day s reurn. Buy-sell imbalance is repored for invesors a a large discoun 14

17 brokerage, a large reail brokerage, a small discoun brokerage, and for insiuional money managers following momenum, value, and diversified sraegies. Invesors a he large discoun brokerage display he greaes amoun of aenion-based buying for hese reurns sors. When calculaed by number of rades, he buy-sell imbalance of invesors a he large discoun brokerage is 9.4 percen for he vingile of socks wih he wors reurn performance on he previous day. drops o 1.8 percen in he eighh reurn decile and rises back o 4 percen for socks wih he bes reurn performance on he previous day. As was he case for abnormal volume, he relaion beween buy-sell imbalance and reurns is quie consisen wih he heoreical model (see appendix). Figure 1b plos average buy-sell imbalance condiional on reurns for 100,000 simulaions based on our heoreical model. Figure 3a plos he buy-sell imbalance based on number of rades for invesors a he large discoun brokerage, he large reail brokerage, and he small discoun brokerage. Noe ha he simulaed and he empirical plos are boh U-shaped. 1 The U-shaped paern is mos pronounced for invesors a he large discoun brokerage; hese invesors buy aenion-grabbing socks. When imbalance is calculaed by value of rades, he buy-sell imbalance of hese invesors is 9.1 percen for he vingile of socks wih he wors reurn performance on he previous day. drops o negaive 8.6 percen in he eighh reurn decile and rises back o 11.1 percen for socks wih he bes reurn performance on he previous day. In Figure 3a, we see ha invesors a he large reail brokerage also display a U-shaped imbalance curve when socks are sored on he previous day s reurn. However, heir endency o be ne buyers of yeserday s big winners is more subdued and does no show up when imbalance is calculaed by value. Invesors a he small discoun brokerage are ne buyers of yeserday s big losers bu no he big winners. 1 Buy-sell imbalances are very similar when we pariion socks on same day s reurn raher han on he previous day s reurn. 15

18 As seen in he las six columns of Table II and in Figure 3b, he hree caegories of insiuional money managers reac quie differenly o he previous day s reurn performance. Momenum managers dump he previous day s losers and buy winners. managers buy he previous day s losers and dump winners. Diversified managers do his as well hough no o he same exen. While one migh inerpre purchases of yeserday s winners by momenum managers and he purchases of yeserday s losers by he value managers as aenion moivaed, i seems more likely ha he evens leading o exreme posiive and negaive sock reurns coincided wih changes relaive o he selecion crieria ha hese wo groups of money managers follow. Unlike he individual invesors, hese money managers were no ne buyers on high abnormal volume days, nor is any one group of hem ne buyers following boh exreme posiive and negaive reurns. C. News Sors Table III repors average daily buy-sell imbalance for socks sored ino hose wih and wihou news. Invesors are much more likely o be ne buyers of socks ha are in he news han hose ha are no. 13 When calculaed by number for he large discoun brokerage, buy-sell imbalance is.70 percen for socks ou of he news and 9.35 percen for hose socks in he news. A he large reail brokerage, buy-sell imbalance is 1.84 percen for socks ou of he news and percen for hose in he news. Table III also repors news pariion buy-sell imbalances separaely for days on which individual socks had a posiive, negaive, or zero reurn. Condiional on he sign of he reurn, average imbalances for individual invesors are always greaer on news days han no news days. For boh news and no news days, average imbalances are greaer for negaive reurn days han for posiive reurn days. One possible explanaion for his is ha when sock prices drop invesors are less likely o sell due o he disposiion effec, i.e., he preference for selling winners and holding losers. Alernaively, he differences in imbalances on posiive and negaive reurn days may resul from he execuion of limi orders. Many individual invesors 13 Choe, Kho, and Sulz (000) find ha individual invesors in Korea buy in he days preceding large one day price increases and sell preceding large one day losses. Large one day price moves are likely o be accompanied 16

19 will no monior heir limi orders hroughou he day. On a day when he marke rises, more sell limi orders will execue han buy limi orders. On days when he marke falls, more buy limi orders will execue. Unforunaely, our daases do no disinguish beween execued limi and marke orders. To es he robusness of our news sor resuls, we calculae buy-sell imbalances for news and no-news days during four day periods surrounding earnings announcemens (he day prior o he announcemen, he day of he announcemen, and he wo days subsequen o he announcemen) and during non-earnings announcemen periods. For boh earnings and nonearnings periods, invesors a all hree brokerages have a greaer propensiy o buy (raher han sell) socks ha are in he news. 14 D. Size Pariions To es wheher our resuls are driven primarily by small capializaion socks, we calculae buy-sell imbalances separaely for small, medium, and large capializaion socks. We firs sor and pariion all socks as described above on he basis of same day abnormal rading volume, he previous day s reurn, and same day news. We hen calculae imbalances separaely for small, medium, and large capializaion socks using he same break poins o form abnormal volume and reurn deciles for all hree size groups. We use monhly New York Sock Exchange marke equiy breakpoins o form our size groups. 15 Each monh we classify all socks (boh NYSE lised and non-lised socks) wih marke capializaion less han or equal o he 30 h percenile break poin as small socks, socks wih marke capializaion greaer han he 30 h percenile and less han or equal o he 70 h percenile as medium socks, and socks wih marke capializaion greaer han he 70 h percenile as large socks. Table IV, repors buy-sell imbalances by size group for abnormal volume, reurn, and news sors. To by news. Choe, Kho, and Sulz poin ou ha he savvy rading of Korean individual invesors could resul from insider rading. 14 During earnings announcemen periods, buy-sell imbalance calculaed by number of rades a he large discoun brokerage is percen on days wih news and 5.14 percen on days wihou news; a he small discoun brokerage 8.57 percen and -.67 percen, respecively; and a he large reail brokerage, 7.5 percen and 1.63 percen. During non-earnings announcemen periods, buy-sell imbalance a he large discoun brokerage is 9.01 percen on days wih news and.53 percen on days wihou news; a he small discoun brokerage, 6. percen and 0.75 percen; and a he large reail brokerage 17.3 percen and.51 percen. 15 We hank Ken French for supplying marke equiy breakpoins. These breakpoins are available and furher described a hp://web.mi.edu/kfrench/www/daa_library/de_me_breakpoins.hml. 17

20 conserve space we repor imbalances for he invesors mos likely o display aenion-based buying: hose a he large discoun brokerage. Resuls for he large reail and small discoun brokerages are qualiaively similar. 16 By and large, invesors are more likely o buy raher han sell aenion-grabbing socks regardless of size. This is rue for all hree of our aenion-grabbing measures: abnormal rading volume, reurns, and news. Many documened reurn anomalies, such as momenum and pos earning announcemen drif, are greaer for small capializaion socks han for large socks. Some researchers have suggesed ha hese phenomena may be caused by he rading behavior of individual invesors. We find, however, ha aenion-based buying by individuals is as srong for large capializaion socks as for small socks. I may be ha he individual invesor s psychology of invesing is similar for large and small socks bu ha, due o rading coss and oher limis of arbirage, he impac he individual invesor s psychology is greaer for small socks. V. Shor-sale Consrains We argue ha because individual invesors hold small porfolios and don sell shor, aenion is more imporan when choosing socks o buy from a huge se of choices, han when choosing socks o sell from a small se. Shor-sale consrains could conribue o our empirical findings hrough a somewha differen mechanism. An aenion-grabbing even may increase heerogeneiy of invesor beliefs abou a firm. Individual invesors who become bullish are able o buy he sock, bu hose who become bearish can sell i only if hey already own i or are willing o sell shor. Insiuional invesors can boh buy and sell. Thus, on average, bullish individuals and insiuions buy aenion-grabbing socks while bearish insiuions, bu no individuals, sell. Thus aenion-grabbing evens are associaed wih ne buying by individuals, no because individuals are buying wha caches heir aenion, bu because hey can sell wha caches heir aenion; aenion-grabbing evens are increasing 16 The only significan excepion o his paern is ha buy-sell imbalances a he large reail brokerage for large capializaion socks are no greaer for deciles of high previous day reurns han for he middle reurn deciles. For small cap and medium cap socks, hese reail invesors do demonsrae a greaer propensiy o buy yeserday s winners han yeserday s average performers. 18

21 heerogeneiy of beliefs while limied porfolios and shor sale consrains resric would be sellers. We believe ha increased heerogeneiy of beliefs combined wih selling consrains may conribue o ne buying by individuals around aenion-grabbing evens. However, even when individuals have boh he opion o buy or o sell a sock i.e., when hey already own he sock, aenion will maer more for buying. This is because each poenial purchase even of a sock already in he porfolio is compeing wih housands of oher socks for aenion, and hus aenion-grabbing socks are more likely o be purchases. Since he choice se is small, all poenial sales can be considered regardless of wheher hey arac aenion. We furher es our aenion hypohesis by examining how individual invesors buy and sell he socks ha hey already own. If shor-sale consrains alone maered and aenion did no oherwise differenially affec buying and selling, we would expec aenion-grabbing evens o similarly increase boh he sales and he purchases of socks ha invesors already own. The aenion hypohesis makes a differen predicion. The aenion hypohesis saes ha aenion is imporan when invesors face a search problem. As discussed above, mos individual invesors do no face a formidable search problem when choosing a sock o sell, bu hey do when buying. Socks hey already own compee wih housands of oher socks as poenial purchases. Thus aenion affecs he rae a which socks are purchased, even socks ha are already owned. Of course invesors are, overall, more likely o sell socks hey already own han o buy hese socks. Under he aenion hypohesis, however, he buy-sell imbalance of socks ha invesors already own should be greaer on days ha hose socks are aenion-grabbing. In Table V, we repor buy-sell imbalances for individual invesors for abnormal volume, reurn, and news sors for socks. In calculaing imbalances for his able, we consider only purchases and sales by each invesor of socks he or she already owns. Since invesors mosly sell socks ha hey already own, bu ofen buy socks ha hey do no own, a far greaer proporion of hese rades are sales. Therefore nearly all of he imbalances are negaive. The relaive paerns of imbalances are, however, similar o hose repored for individual 19

22 invesors in Tables I, II, and III. The raio of purchases o sales is higher on high aenion days. This is paricularly rue for he abnormal volume sor (Panel A) and he news sor (Panel C). When socks are sored on he previous day s reurn (Panel B), invesors are relaively more likely o purchase socks hey already own on days following large negaive reurns han on oher days. However, following large posiive reurns, buy-sell imbalances do no increase as hey do for all socks, regardless of curren ownership (as repored in Table II). I is likely ha for socks invesors already own, he disposiion effec influences heir purchases as well as heir sales. Odean (1998a) repors ha invesors are more likely o purchase addiional shares of socks hey already own if he share price is below, raher han above, heir original purchase price. As prediced by Prospec Theory (Kahneman and Tversky, 1979), invesors assume more risk when in he domain of losses han when in he domain of gains. The resuls in Table V, Panel C, are consisen wih his. Thus shor-selling consrains (and heerogeneiy of beliefs) do no fully explain our findings. For individual invesors who can sell a sock wihou selling shor, a higher percenage of heir rades are purchases raher han sales on high aenion days. VI. Asse Pricing: Theory and Evidence In he appendix, we develop a model of price formaion for a marke in which uninformed invesors end o buy socks ha cach heir aenion. Our heoreical model has he esable predicion ha he underperformance of he socks bough relaive o socks sold by uninformed aenion-based invesors will be greaes following periods of high aenion. The inuiion underlying his resul is sraighforward; uniformed invesors creae buying pressure in aenion-grabbing socks, and marke makers respond o his buying pressure by increasing prices, leading o lower subsequen reurns. In his secion, we es his reurn predicion. The model does no specify he period of ime over which aenion-based buying affecs reurns. Our evidence ha invesors do buy socks ha cach heir aenion is based upon one day sors. I is likely, hough, ha invesors aenion spans more han a single day. Furhermore, he period over which he socks bough by aenion-based invesors will 0

23 underperform he socks hey sell depends upon how swifly he signals of informed invesors become public knowledge. In he following analysis, we look for underperformance of socks bough by aenion-based invesors over a one monh horizon. We obain similar resuls a oher horizons. To es he model s predicion, we firs sor socks ino decile pariions on he basis of he curren day s abnormal rading volume and on he basis of previous day s reurn and hen, for each pariion, we form wo porfolios: a porfolio of socks purchased by individual invesors and a porfolio of socks sold by hem. We hen calculae he difference in he reurns of hese wo porfolios, for each pariion. On each day, we consruc a porfolio comprised of hose socks purchased wihin he las monh (1 rading days). The reurn on he porfolio is calculaed based on he value of he iniial purchase as: R b = n b x i i= 1 n b i= 1 R x i i (4) where R i is he gross daily reurn of sock i on day, n b is he number of differen socks purchased during he pas monh, and x i is he compound daily reurn of sock i from he close of rading on he day of he purchase hrough day -1 muliplied by he value of he purchase. For each pariion, a porfolio of socks sold wihin he las monh is similarly consruced. For our empirical ess, we compound daily reurns o yield a monhly reurn series. Our predicion is ha, for higher aenion pariions, here will be greaer underperformance of he purchase porfolios relaive o he sales porfolios; ha is, ( R - R ) will be increasing in aenion. s b We calculae he difference in he reurns ( R - R ) for he weny pairs of purchase and sale porfolios (en deciles based on abnormal volume sors, and en deciles based on previous day s reurn sors). To see wheher any observed abnormal reurns can be explained by sock characerisics known o affec reurns, we employ a four-facor model ha includes marke, size, value, and momenum facors (Carhar (1997)). For example, o evaluae he reurn b s 1

24 performance of in a paricular decile ( R - R ), we esimae he following monhly ime-series regression: b s b s ( R R ) α j β j( Rm R f) s jsmb hjvmg m jwml ε j, = (5) where R f is he monhly reurn on T-Bills, 17 R m is he monhly reurn on a value-weighed marke index, SMB is he reurn on a value-weighed porfolio of small socks minus he reurn on a value-weighed porfolio of big socks, VMG is he reurn on a value-weighed porfolio of high book-o-marke (value) socks minus he reurn on a value-weighed porfolio of low book-o-marke (growh) socks, and WML is he reurn on a value-weighed porfolio of recen winners minus he reurn on a value-weighed porfolio of recen losers. 18 regression yields parameer esimaes of α j, β j, sj, hj and mj. The error erm in he regression is denoed by ε j. The subscrip j denoes parameer esimaes and error erms from regression j, where we esimae weny-one regressions. The In Table VI, Panel A, we repor, for he combined sample, reurns for he difference in reurns earned by purchase and sale porfolios for deciles of socks firs sored on he curren day s abnormal rading volume. Because he shor ime periods of he large reail and small discoun samples, we repor resuls for he sample of combined rades for invesors a all hree brokerages. 19 In Panel B, we repor, for he combined sample, reurns for he difference in reurns earned by purchase and sale porfolios for deciles of socks firs sored on he previous day s abnormal reurn. In all hree of our high-aenion deciles decile 10 for he abnormal volume sor and deciles 1 and 10 for he reurn sor he underperformance of socks purchased relaive o hose sold is boh economically and saisically significan. This underperformance is virually unchanged afer accouning for he reurn facors in he fourfacor model. In many of he low aenion deciles, he porfolios of socks purchased 17 The reurn on T-bills is from Socks, Bonds, Bills, and Inflaion, 1997 Yearbook, Ibboson Associaes, Chicago, IL. 18 We consruc he WML porfolio as in Carhar (1997), hough we value-weigh raher han equally-weigh he momenum porfolio. The consrucion of he SMB and VMG porfolios is discussed in deail in Fama and French (1993). We hank Kenneh French for providing us wih he remaining daa. 19 The combined reurn series resuls in a ime-series of monhly reurns from February 1991 hrough June In monhs when we have reurns from more han one daase, we average across daases.

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