Paper: "Why Do Individuals Exhibit Investment Biases?"

Abstract of a fascinating new paper, "Why Do Individuals Exhibit Investment Biases?"

We find that a long list of investment biases, e.g., the reluctance to realize losses, performance chasing, and the home bias, are "human," in the sense that we are born with them. Genetic factors explain up to 50% of the variation in these biases across individuals. We find no evidence that education is a significant moderator of genetic investment behavior. Genetic effects on investment behavior are correlated with genetic effects on behaviors in other domains (e.g., those with a genetic preference for familiar stocks also exhibit a preference for familiarity in other domains), suggesting that investment biases is only one facet of much broader genetic behaviors.

This is incredible. I'm surprised the paper (which is new) has been downloaded less than 100 times. They used data from the Sweden Twin Registry, matched with data on the twins' investment behaviors, in order to decompose differences into genetic and environmental components.

The study seems top notch, they even exclude all individuals for whom the equity portfolio does not constitute at least 20% of their total assets, which reduced the sample size, but enabled them to exclude those for whom the equity portfolio was insignificant and who would not have strong incentives to carefully consider their investment behaviors.

They even looked at skewness preference, which is what causes investors to gravitate towards the "lottery-type" stocks, causing the worthless stock inefficiency!

From a Credit Bubble Stocks correspondent,

It is interesting to see economists using twin studies to measure the heritability of an economic behavior. That is news to me.

A lot of knowledge is innate, created by evolution and built into the nervous system by sculpting away everything that is extraneous and energy-expensive, so that, for example, a brain the size of a grain of sand can guide a bee or a bumble bee through all of the complex economic decisions in its daily life, but not be able to compose a concerto. This book - Complex Worlds from Simpler Nervous Systems - will impress you with the complex economic decisions that tiny insect brains can make.

Twin studies work because identical twins share all of their genes, while the average proportion of shared genes is only 50% for fraternal twins. If identical twins exhibit more behavioral similarity than do fraternal twins, then there is evidence that these behaviors are influenced, at least in part, by genetic factors.

The authors here conclude that for each measure of investment bias, the correlation was significantly greater between identical than fraternal twins. Also, the correlation between twins and random age- and gender-matched non-twins was close to zero, which would indicated that either genes or the common parental environment were causing the investment biases.

The Complex Worlds book looks quite interesting. Reading the forward, it mentions the test that fiddler crabs use to distinguish predators from conspecifics: "does this moving object intersect the horizon?" Anything above a line from the crab's eye to the horizon is bigger than the crab, "and so is probably bad news"!