"Psychological evidence (shows) that anxious people
make pessimistic probability estimates, are biased
in terms of the amounts and types of information they utilize, and
are thus motivated to reduce the level of risks they face".
"The Nobel economist Gary Becker has argued that people
don't respond to risk - they respond to fear. The probability
of a bad event might be extremely small, but if the thought of it
provokes a lot of fear, people will alter their behavior anyway.
Likewise, the risk of a bad event might be substantial, but if there
is no fear, people will fail to alter their behavior, sometimes
with catastrophic results. Unfortunately, what provokes fear in
the markets is a decline already in progress. So rather than reducing
their exposure as soon as risks have measurably increased, they
try to reduce their exposure when a market decline is already a
Pessimism, Hurley and Fuller, 2001
"Cognitive psychologists use the term "saliency"
to refer to how the human brain reacts to extremely traumatic
events. The more traumatic and more recent the event, the greater
the human brain assumes its probability of recurring, regardless
of the actual probability of a similar event. The brain
simply chooses to ignore other factors that might affect a particular
event or circumstance".
Interest and Stock Returns, Asquith, Pathak & Ritter, 2004
"Whether or not short sellers can profit from a short selling
strategy, the finding that heavily shorted stocks underperform the
market has other important investment implications. An investor
selecting stocks for a portfolio should avoid stocks with a high
short interest ratio. If an investor already owns a stock that develops
sustained high short interest, the clear and strong
advice is to sell the stock immediately. Consistent
with other studies, we find that the higher the short interest ratio,
the lower is the subsequent performance. That is, firms with short
interest ratios of 10% or more underperform those of 5% or 2.5%".
Prior to Earnings Announcements, Christophe, Ferri and Angel,
This article examines short-sales transactions in the five days
prior to earnings announcements of 913 Nasdaq-listed firms. The
tests provide evidence of informed trading in pre-announcement short-selling
because they reveal that abnormal short-selling is significantly
linked to postannouncement stock returns. We believe that these
results should encourage financial market regulators to consider
providing more extensive and timely disclosures of short-selling
Investor Sentiment, and Evolution, WANG, 2001
"We find that underconfidence or pessimism cannot survive,
but moderate overconfidence or optimism can survive and even dominate,
particularly when the fundamental risk is large. These findings
provide new empirical implications for the survivability of active
fund management. Our results lend support to the relevance of the
psychology of investors in studying financial markets".