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Now you see it now you don't: The effectiveness of the recognition heuristic for selecting stocks

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  • Patric Andersson
  • Tim Rakow
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    Abstract

    It has been proposed that recognition can form the basis of simple but ecologically rational decision strategies (Gigerenzer \& Goldstein, 1996). Borges, Goldstein, Ortmann, \& Gigerenzer (1999) found that constructing share portfolios based on simple name recognition alone often yielded better returns than the market index. We describe four studies with seven samples of participants from three countries (total N = 319) in which the returns of recognized and unrecognized shares from several stock markets were tracked over various periods of time. We find no support for the claim that a simple strategy of name recognition can be used as a general strategy to select stocks that yield better-than-average returns. However, there was some suggestion in the data that recognition performs better when the market is falling and worse when it is rising. A follow-up study indicated that the absence of an overall recognition effect could not easily be attributed to our reliance on student participants or smaller samples than Borges et al.\ (1999) had used. We conclude that, with respect to changes in value, selecting stocks on the basis of name recognition is a near-random method of portfolio construction that offers little, if any, benefit to the personal investor.

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    Bibliographic Info

    Article provided by Society for Judgment and Decision Making in its journal Judgment and Decision Making.

    Volume (Year): 2 (2007)
    Issue (Month): (February)
    Pages: 29-39

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    Handle: RePEc:jdm:journl:v:2:y:2007:i::p:29-39

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    Keywords: heuristics; recognition; investment.;

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    1. Merton, Robert C., 1987. "A simple model of capital market equilibrium with incomplete information," Working papers 1869-87., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    2. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    3. Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2002. "Breadth of ownership and stock returns," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 171-205.
    4. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
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