Leverage and Beliefs: Personal Experience and Risk-Taking in Margin Lending

Abstract

Distressed sales (or purchases) often lead to a V-shaped pattern in asset prices. We investigate the underlying dynamics of this overshooting of the price in a unique historical setting. We present detailed transaction data for two cases of distressed trading in the Amsterdam stock market in 1772 and 1773. We show that there is an interesting disconnect between the realization of the shock and price overshooting on the one hand, and the actual distressed trading on the other. A large fraction of trades were delayed until the overshooting of the price had been corrected. Using qualitative sources we document signi…cant contemporary uncertainty about the size of the shock. We argue that a model based on this uncertainty could potentially explain the disconnect between price overshooting and the timing of transactions.

Fully Closed: Individual Responses to Realized Gains and Losses

“…Furthermore, we find that individuals exit stock markets, which implies that personal experiences are relevant for stock market nonparticipation and for the low portfolio shares that we empirically observe. Based on our findings, we conclude that individuals appear to become more risk-averse or expect lower returns or higher volatility in response to losses, in line with the findings of Malmendier and Nagel (2011) and Koudijs and Voth (2016). These papers consider sophisticated groups of individuals.…”

“…He argues in favor of a preference channel based on the framing of gains and losses. Second, as in Koudijs and Voth (2016), we find evidence for a risk-aversion channel by showing that risk-taking along the intensive margin is affected. Individuals invest less in securities classified as higher risk or that have high CAPM (Capital Asset Pricing Model) betas.…”

“…In contrast, Kaustia and Knüpfer (2008) and Anagol, Balasubramaniam, and Ramadorai (2018) have perfectly random assignment of IPO investment opportunities, but these represent less large shocks for a select group of individuals. Koudijs and Voth (2016) consider archival data and a nice natural experiment on collateralized lending but we may not be able to extrapolate from their historical episode to today's investors. The mutual funds considered in our setting should be more representative of a typical household's investment opportunities and the average value of our mutual fund investments is large.…”

“…Second, we also contribute to studies, such as Andersen, Hanspal, and Nielsen (2019), Malmendier and Nagel (2011), Anagol, Balasubramaniam, and Ramadorai (2018), and Koudijs and Voth (2016) on how personal experiences in stock markets affect individuals' behaviors. 3 In addition, show that individuals save less in their 401(k)s after their portfolio returns are 3 In another paper, using the same data we examine the marginal propensity to consume out of forced liquidations.…”

Doing Less With More

“…The literature tends to assign a specific role for leverage: it facilitates risk-taking by the most optimistic individuals. And there is both theoretical (e.g., Scheinkman and Xiong [2003], Simsek [2013]) and empirical support for this channel (e.g., Ben-David [2011], Koudijs andVoth [2016], Bailey et al [2017]). Instead, we find that financial leverage lets individuals delay making painful decisions.…”