Publications et Travaux

Cognitive Biases and their Implications for Price Formation on Financial Markets

Behavioral Finance argues that several anomalies could be explained by relaxing the central proposition of EMH (Efficient Market Hypothesis), that is, investors’ rationality. Indeed, recent empirical and experimental work provides additional evidence that human judgment errors may impact financial market price behavior instead of simply canceling each other out. Our work aims to provide a better understanding of several cognitive biases, human judgment errors occurring during mental information processing and decision making. We propose a general mathematical framework of price formation, allowing for subsequent modeling of individual cognitive biases, without affecting the underlying assumptions. Price characteristics, such as expected equilibrium price, volatility but also trading volumes, can be potentially analyzed for each bias’ functional form. This theoretical work on some specific cognitive biases allowed for further empirical research, using quarterly earnings estimates, announcements and subsequent price reaction data for listed US companies over the period 1983-1999. We selected events, for which previous earnings information pointed to a highly probable bias; which could be either an anchoring bias to previous earnings values or a representativeness bias given a series of past earnings surprises. We showed that these events exhibit, at the time of the current earnings announcement, important and highly significant abnormal returns, indicating a correction phenomenon of the (assumed) previous under- or over-reaction.

Anomalous Price Behavior following Earnings Announcements - does Representativeness cause Overreaction ?

Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. Two kinds of anomalies, namely underreaction and overreaction, have been established by an impressive record of empirical work. While underreaction defines a slow adjustment of prices to corporate events or announcements, overreaction deals with extreme stock price reactions to previous information or past performance. This study investigates current and past earnings surprises for listed US companies over the period 1983-1999. It provides evidence that investors exhibit long-term overreaction to past, highly unexpected, earnings surprises. Investors tend to overestimate (underestimate) future earnings after extreme positive (negative) earnings surprises. As, on average, these extreme past surprises are not confirmed by subsequent earnings figures, they are followed by a correction of the initial overreaction at the date of the subsequent earnings announcement. Moreover, the longer the similar earnings surprise series, the higher the subsequent correction, suggesting that representativeness may cause this overreaction phenomenon

To Buy or Not to Buy UMTS Licenses? A Real Options Approach

This article describes a methodology for evaluating UMTS licenses using a real options approach. The acquisition of the license is viewed as the right to undertake the infrastructure investments that the firm can defer. The value of this license equals the value of the investment opportunity. The investment is assumed to be instantaneous and the cash flows associated with the investment are uncertain. This uncertainty of future cash flows might make it attractive to wait before investing even if the expected NPV is positive. The solution specifies the cash flow threshold, where NPV equals the option value and when it the investment should be undertaken. We simulate the impact of different variables (volatility, expected growth rate of cash flows, investment cost, ...) on the investment rule. Note: Downloadable document is in French. Keywords: UMTS licences, real options, simulation JEL Classifications: G31,E27

Investors Misreaction to Unexpected Earnings: Evidence of Simultaneous Overreaction and Underreaction

Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. Two kinds of anomalies, namely underreaction and overreaction, have been established by an impressive record of empirical work. While underreaction defines a slow adjustment of prices to corporate events or announcements, overreaction deals with extreme stock price reactions to previous information or past performance. Theoretical models have shown that both phenomena find potential explanations in cognitive biases, that is, investor irrationality. This study investigates current and past earnings surprises and subsequent market reaction for listed US companies over the period 1983-1999. The results suggest that investors simultaneously exhibit short-term underreaction to earnings announcements and long-term overreaction to past highly unexpected earnings. A potential explanation for the reported overreaction phenomenon is the representativeness bias. As I show, the overreaction and the later reversal is stronger for events, which exhibit a long series of similar past earnings surprises. Keywords: behavioral finance, overreaction, underreaction, representativeness, earnings announcements JEL Classifications: G14, D84

Investors Misreaction to Unexpected Earnings: Evidence of Simultaneous Overreaction and Underreaction

Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. Two kinds of anomalies, namely underreaction and overreaction, have been established by an impressive record of empirical work. While underreaction defines a slow adjustment of prices to corporate events or announcements, overreaction deals with extreme stock price reactions to previous information or past performance. Theoretical models have shown that both phenomena find potential explanations in cognitive biases, that is, investor irrationality. <br /><br />This study investigates current and past earnings surprises and subsequent market reaction for listed US companies over the period 1983-1999. The results suggest that investors simultaneously exhibit short-term underreaction to earnings announcements and long-term overreaction to past highly unexpected earnings. A potential explanation for the reported overreaction phenomenon is the representativeness bias. As I show, the overreaction and the later reversal is stronger for events, which exhibit a long series of similar past earnings surprises. <br /><br />Keywords: behavioral finance, overreaction, underreaction, representativeness, earnings announcements <br /><br />JEL Classifications: G14, D84

Anomalous Price Behavior Following Earnings Surprises: Does Representativeness Cause Overreaction?

Behavioral Finance aims to explain empirical anomalies by introducing investor psychology as a determinant of asset pricing. Two kinds of anomalies, namely underreaction and overreaction, have been established by an impressive record of empirical work. While underreaction defines a slow adjustment of prices to corporate events or announcements, overreaction deals with extreme stock price reactions to previous information or past performance. This study investigates current and past earnings surprises for listed US companies over the period 1983-1999. It provides evidence that investors exhibit long-term overreaction to past, highly unexpected, earnings surprises. Investors tend to overestimate (underestimate) future earnings after extreme positive (negative) earnings surprises. As, on average, these extreme past surprises are not confirmed by subsequent earnings figures, they are followed by a correction of the initial overreaction at the date of the subsequent earnings announcement. Moreover, the longer the similar earnings surprise series, the higher the subsequent correction, suggesting that representativeness may cause this overreaction phenomenon. Keywords: behavioral finance, overreaction, representativeness bias, earnings announcements JEL Classifications: G14, D84

PDFs

 

Modélisation de l’existence de biais cognitifs sur la formation des prix sur les marchés financiers

 

Rétrospective d’un siècle de modélisation en Finance

 

Quel prix pour les licences UMTS ? Une approche par les options réelles

   

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Hedge Fund Activism: A Clinical Study of the French Company Atos Origin

Over the period from October 2006 to May 2008, Atos Origin, a French information technology company, was the target of two activist hedge funds, Centaurus and Pardus. This article investigates in detail how the activists initiated their actions, how the management organized its defence and how both were received by the market. We find that, although Atos looked like an attractive opportunity, the funds failed in their primary objective, the sale of the target. In fact, the chairmen of Atos succeeded in discrediting the two hedge funds by taking support on the French context, not particularly prone to and sometimes even hostile towards shareholder's interests. Our findings suggest that this context can create a strong support to managers' entrenchment when facing activists. We also show that the success/failure classification used in large-sample studies, and based on officially stated goals, bears a considerable risk for misinterpretation. As our case shows, those objectives can not only change throughout the activism process, but may also be disclosed in different (and not exclusively official) ways. Relying solely on stated goals can significantly distort the overall judgement on the success of activism.