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>Home Page >Behavioral Finance >Pessimism and Saliency (see also Glitter Effects ):
[Huang] "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".
[Hussman] "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 fait accompli".

Irrational 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".

Short 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%".
Short-Selling Prior to Earnings Announcements, Christophe, Ferri and Angel, 2004
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 to investors.
Overconfidence, 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".