Are All Professional Investors Sophisticated?

Abstract

Existing empirical evidence is inconclusive as to whether professional investors show more sophisticated behavior than individual investors. Therefore, we study two important groups of professional investors and compare them with laymen by means of a survey covering about 500 investors. We find that some professionals, i.e. institutional investors, behave in a more sophisticated manner than laymen, whereas the less researched investment advisors seem to do even worse. Our survey approach complements available evidence due to its design: it compares professionals with (qualified) interested laymen, it covers six measures of sophisticated behavior, uses several control variables and strictly compares investment decisions in the private domain. Copyright 2010 The Authors. German Economic Review 2010 Verein für Socialpolitik.

We expect stocks to rise, but we do not know when and which ones: Excessive optimism in predicting future stock indices returns

“…Previous research showed that the predictions of financial professionals in the investment field were rather inaccurate and excessively optimistic (Shiller, 2000;Abarbanell & Lehavy, 1993;Kothari, 2001;Bradshaw, 2011;DeBondt & Thaler, 1990;Easterwood & Nutt, 1999). Moreover, it was shown that professionals were sometimes more inaccurate than the lay people (Staël von Holstein, 1972;Yates, McDaniel, & Brown, 1991;Menkhoff, Schmeling, & Schmidt, 2013;Glaser, Langer, & Weber, 2005). According to these findings, we hypothesized that group of financial professionals would be excessively optimistic in predicting future returns of stock indices.…”

“…Some of the research on predicting future equity returns found that forecasts of financial professionals are often more inaccurate compared to the lay people (Staël von Holstein, 1972;Yates, McDaniel, & Brown, 1991;Menkhoff, Schmeling, & Schmidt, 2013;Glaser, Langer, & Weber, 2005). They hypothesized about an inverse effect of expertise in explaining this paradox.…”

“…Yates, McDaniel, and Brown (1991) in their research included and compared semi-experts (PhD students in finance) and non-experts (novice students in finance). Menkhoff, Schmeling and Schmidt (2013) included institutional investors, advisors and private investors. Finally, Glaser, Langer, and Weber (2005) included bankers and students.…”

“…Many authors found that predictions of financial professionals about the future returns of assets are very inaccurate and miscalibrated (Barber & Odean, 2001;BenDavid, Graham, & Harvey, 2010;Sonsino & Regev, 2013). In addition, it was shown that predictions of professionals are often more inaccurate than predictions of lay people and this lead to a conception of a hypothesis about an inverse effect of expertise in predicting (Staël von Holstein, 1972;Yates, McDaniel, & Brown, 1991;Menkhoff, Schmeling, & Schmidt, 2013;Glaser, Langer, & Weber, 2005). What is important is that the research on excessive optimism extends these results and shows that these inaccurate predictions are biased mostly positively (see reviews by Brown, 1993;and Kothari, 2001).…”

“…We used a classical method of estimating 95% confidence intervals, which is widely used in the research on overconfidence when measuring miscalibration but also in observing excessive optimism (e.g., Menkhoff, Schmeling, & Schmidt, 2013;Sonsino & Regev, 2013;Toshino & Suto, 2004). The participants were instructed as follows:…”