Academic journal article Financial Management

How Much Does Expertise Reduce Behavioral Biases? the Case of Anchoring Effects in Stock Return Estimates

Academic journal article Financial Management

How Much Does Expertise Reduce Behavioral Biases? the Case of Anchoring Effects in Stock Return Estimates

Article excerpt

We use data from surveys involving 300 Scandinavian financial market professionals and 213 university students to conduct three controlled experiments in which we manipulate the background information given to subjects. We find a very large anchoring effect in the students' long-term stock return expectations, that is, their estimates are influenced by an initial starting value. Professionals show a much smaller anchoring effect, but it nevertheless remains statistically and economically significant, even when we restrict the sample to more experienced professionals. We also find that the professionals are not conscious of the impact of historical returns on their expectations.


The question of how individuals form stock market return expectations has received increasing attention, and survey-based studies directly asking for these expectations have appeared in recent years (e.g., Welch, 2000; Bange, 2000; Fraser, 2004; Graham and Harvey, 2005; Glaser and Weber, 2005). However, we know very little about how financial advisers form their return expectations. Advisers and other financial market professionals play an influential role in matching financial products and individual investors, and their return expectations are likely to have a significant impact on their clients' asset allocation decisions.

We are particularly interested in finding out if professionals' expectations are affected by behavioral biases. Numerical estimates are often influenced by an initial starting value, a process known as "anchoring and adjustment." (1) Anchoring is one of the three original decisionmaking heuristics, and since the classic study by Tversky and Kahneman (1974), anchoring effects have been documented in studies on, for example, real estate valuation (Northcraft and Neale, 1987), effort or task motivation (Switzer and Sniezek, 1991), and consumers' purchasing decisions (Wansink, Kent, and Hoch, 1998). Anchoring may also be a powerful force in financial markets (see Shiller, 1999, for discussion). Some studies have shown that experts, too, can suffer from anchoring bias (Northcraft and Neale, 1987; Englich, Mussweiler, and Strack, 2006). (2) On the other hand, a vast majority of studies on anchoring, as well as other experimental studies in decision making, have used student subjects. A strong presupposition in the economics literature is that more sophisticated subjects behave fundamentally differently, as they learn from experience to avoid biases and their behavior is also influenced by higher incentives. A series of field experiments utilizing the market for sports memorabilia reported in List (2003, 2004a, 2004b, 2006) support the notion that experience indeed attenuates behavioral biases in general. Hence, anchoring effects may not be so important in practical decision-making contexts.

Previous studies comparing the decision making of financial market professionals and students find that whether or not professionals are less biased depends on the context. Haigh and List (2005) find that the floor traders at the Chicago Board of Trade (CBOT) demonstrate a greater degree of myopic loss aversion than students. Alevy, Haigh, and List (2007) find that students more closely follow Bayes' rule, whereas CBOT professionals are better at assessing the quality of public information, and thus earn higher profits.

In this paper, we carry out three controlled experiments: we asked 300 Scandinavian financial advisers and other professionals about their stock return expectations, while varying the information that is first provided to them. Our paper differs from prior manipulation experiments in finance. Jordan and Kaas (2002) investigate the effect of viewing different types of mutual fund ads on expectations. Bloomfield and Michaely (2004) study the effect of variation in beta and book-to-market to perceptions on expected returns, risk, and mispricing. Glaser, Langer, Reynders, and Weber (2007) study the impact of asking for subjects' expectations in terms of returns versus prices. …

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