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Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders

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  • Francis Larson
  • John A. List
  • Robert D. Metcalfe

Abstract

Behavioral economists have recently put forth a theoretical explanation for the equity premium puzzle based on combining myopia and loss aversion. Complementing the behavioral theory is evidence from laboratory experiments, which provide strong empirical support consistent with myopic loss aversion (MLA). Yet, whether, and to what extent, such preferences underlie behaviors of traders in their natural domain remains unknown. Indeed, a necessary condition for the MLA theory to explain the equity premium puzzle is for marginal traders in markets to exhibit such preferences. Using minute-by-minute trading observations from over 864,000 price realizations in a natural field experiment, we find data patterns consonant with MLA: in their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information. Beyond testing theory, these results have important implications for efficient resource allocation as well as characterizing the optimal structure of social and economic policies.

Suggested Citation

  • Francis Larson & John A. List & Robert D. Metcalfe, 2016. "Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders," NBER Working Papers 22605, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22605
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    References listed on IDEAS

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    1. Bellemare, Charles & Krause, Michaela & Kroger, Sabine & Zhang, Chendi, 2005. "Myopic loss aversion: Information feedback vs. investment flexibility," Economics Letters, Elsevier, vol. 87(3), pages 319-324, June.
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    3. Azeredo, Francisco, 2007. "The Equity Premium: A Deeper Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt6ks5p6v5, Department of Economics, UC Santa Barbara.
    4. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
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    6. Michael S. Haigh & John A. List, 2005. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Journal of Finance, American Finance Association, vol. 60(1), pages 523-534, February.
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    Cited by:

    1. Valentin Haddad & Marianne Andries, 2014. "Information Aversion," 2014 Meeting Papers 1091, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • C93 - Mathematical and Quantitative Methods - - Design of Experiments - - - Field Experiments
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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