The Effect of Past Experiences on Preferences and Beliefs Econ 196, Berkeley November 16, 2011 Paper 1: Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking? “I don’t know about you, but my parents were depression babies, and as a result, avoided the stock market and all things risky like the plague.” Source: moneytalks.org (“Investing: The Basics”)MotivationMotivationApplication: Financial decision-making and risk-takingDataMeasures of Risk-TakingMeasures of Experienced ReturnsWeighting FunctionTable I: Summary StatisticsTable I: Summary Statistics (continued)EstimationIdentificationExampleIdentification IssuesIdentification – Previous LiteratureMeasure 1: Elicited Risk AversionMeasure 1: Elicited Risk AversionMeasure 1: Elicited Risk AversionTable II: Elicited Risk AversionInterpretationMeasure 2: Stock-Market ParticipationTable III: Stock-Market Participation (Probit)InterpretationMeasure 3: Risky-Asset PortionTable IV: Risky Asset Share (NLS)InterpretationMeasure 4: Bond ShareTable V: Bond Share (NLS)InterpretationInterpretation (II)Robustness Checks – and Ideas for your researchRobustness Checks – and Ideas for your research (II)Aggregate PerspectiveFigure 4Figure 6InterpretationConclusionsConclusionsFollow Up I: InflationResultsDisagreement about future inflation (one-year horizon)ResultsFollow Up II: Effect on Corporate DecisionsFollow Up II: Effect on Corporate DecisionsSwitching Gears to Other “Personal Traits”Corporate FinanceThree PuzzlesThree PuzzlesThree PuzzlesThree PuzzlesResearch AgendaResearch AgendaResearch AgendaMotivationManagerial OverconfidenceRelated BiasesTwo PatternsTwo Patterns (II)CEO OverconfidenceSlide Number 64Slide Number 65Slide Number 66Slide Number 67DataEmpirical Experiment (I)Why Hold Options?Slide Number 71Interpretation and Prior ResultsInvestmentInterpretation and Prior ResultsMergersMergers: Announcement EffectEmpirical Experiment (II)Overconfidence InterpretationSummary StatisticsPrediction 1Table 2. Public Security Issuance DecisionsTable 2. Logits (dependent variable: equity issue indicator)Alternative FrameworkTable 5. FD Framework (Dependent Variable: net debt issues)Table 6. Persistence (Dependent Variable: book leverage in year T)Prediction 2Measure of Debt ConservatismTable 7. Tobits (Kink censored above 8)Alternative SpecificationTable 8. LogitsSlide Number 92Summary of ResultsConclusionsConclusions (II)Research Topic1 The Effect of Past Experiences on Preferences and Beliefs Econ 196, Berkeley November 16, 2011 Ulrike Malmendier UC Berkeley2 Paper 1: Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking? Ulrike Malmendier Stefan Nagel UC Berkeley Stanford3 “I don’t know about you, but my parents were depression babies, and as a result, avoided the stock market and all things risky like the plague.” Source: moneytalks.org (“Investing: The Basics”)4 Motivation • Traditional models in economics: – Exogenously endowed and stable preferences – Personally experienced / witnessed outcomes do not affect beliefs differently from information about these outcomes. • Psychology and experimental economics literature: – Experience-weighted (in particular, reinforcement) learning versus information (Camerer and Ho, Econometrica 1999) – Learning from personal interaction (with other players) stronger than from observing other players’ behavior (Simonsohn, Karlsson, Loewenstein, and Ariely, 2007) – Endogenous preference formation (Bowles, JEL 1998; Palacios-Huerta and Santos, JPubE 2004). – Social learning and personal advice (Schotter, AER 2003)5 Motivation  Do individuals’ “histories” systematically affect their decision-making differently than information about the historical outcomes?  For the generation of “Depression Babies” it has often been suggested that their experience of a large macro-economic shock had a long-lasting effect on their attitudes towards risk. Our application: We ask more generally whether people who live through different macroeconomic histories make different risky choices.6 Application: Financial decision-making and risk-taking • Does stock-market experience affect risk attitudes and stock inv.? • Does inflation experience affect bond investment? Illustration: stock-market participation at age 36-45 00.050.10.150.20.250.30.35Cohorts -1920 Cohort 1921-30 Cohorts 1931-40 Cohorts 1941-50 Cohorts 1951-60 Cohorts 1961-707 Data • Survey of Consumer Finances – 1983-2004: Triennial, cross-sectional, household-level – Oversampling of high-income households – Detailed data on asset holdings and demographics • Precursor of Survey of Consumer Finances – 1964-1977: 1964, 1968, 1969, 1970, 1971, 1977 –We use data on stock-market participation.8 Measures of Risk-Taking • Elicited risk aversion (1983-2004): survey – 1 = “willing to take substantial financial risks expecting to earn substantial returns” – 2 = “… above average financial risks .. above av. ret.” – 3 = “…average financial risks … average returns” – 4 = “not willing to take any financial risk” • Stock investment I (1964-2004) – Stock-market participation (stock holdings > $0) • Stock investment II (1983-2004) – Risky asset share of stock-market participants (% of liquid assets in stocks) • Bond investment (1983-2004) – Bond share of bond mkt. participants (% of non-stock liquid assets invested in bonds)9 Measures of Experienced Returns • Ri,t-k: Annual real returns on S&P500 index from Shiller (2005) • Calculate since birth of household head • Life-time (weighted) average returns of household i at t: ( )( )( )( )1111,, where ,,ititageit t kk itit itageititkwk Rage kA wkagewkλλλλλ−−=−=−= =∑∑10 Weighting Function • Chosen to allow increasing, decreasing, constant weights over time with one parameter. • Illustration for 50-year old household: 00.010.020.030.040.050.060.070.080.091 6 11 16 21 26 31 36 41 46 51 56Lag kWeight λ = -0.2λ = 3λ = 111 Table I: Summary Statistics 10 % Median 90 % Mean Stddev N Panel A: All households 1964 – 2004 Liquid assets 800 12,372 216,060 122,909 726,749 33,955 Income 16,430 48,475 109,705 65,457 177,594 33,955 Life-time avg. stock ret. (λ = 1.25) 0.059 0.087 0.110 0.086 0.021 33,955 Life-time avg. inflation (λ = 1.00) 0.023 0.042 0.055 0.039 0.012 33,955 Stock mkt. participation 0 0 1 0.286 0.452 33,955 Panel