Journal Articles (Peer-Reviewed)
Merkle, Christoph (In press): Financial overconfidence over time: Foresight, hindsight, and insight of investors, Journal of Banking & Finance.
Abstract: Abstract Financial overconfidence leads to increased trading activity, higher risk taking, and less diversification. In a panel survey of online brokerage clients in the UK, we ask for stock market and portfolio expectations and derive several overconfidence measures from the responses. Overconfidence is identified in the sample in various forms. By matching survey data with participants’ transactions and portfolio holdings, we find an influence of overplacement on trading activity, of overprecision and overestimation on diversification, and of overprecision and overplacement on risk taking. We explore the evolution of overconfidence over time and identify a role of past success and hindsight on subsequent investor overconfidence in line with learning to be overconfident.
Merkle, Christoph, Philipp Schreiber and Martin Weber (In press): Framing and Retirement Age: The Gap between Willingness-to-Accept and Willingness-to-Pay, Economy Policy.
Abstract: In a large online experiment, we relate the retirement timing decision to the disparity between the willingness-to-accept (WTA) and the willingness-to-pay (WTP). In the WTP treatment, participants indicate the maximum amount of monthly benefits they are willing to give up in order to retire early. In the WTA treatment, the minimum increase of monthly payments in order to delay retirement is elicited. Our results reveal that the framing of the decision problem strongly influences participants' reservation price for early retirement. The willingness-to-accept for early retirement is more than twice as high as the corresponding willingness-to-pay. Using actual values from the German social security system as market prices, we demonstrate that the presentation in a WTA frame can induce early retirement. In this frame, the implicit probability of retiring early increases by 30 percentage points.We further show that the disparity between WTA and WTP is correlated with loss aversion. Repeating the analysis with data from a representative household survey (German SAVE panel), we find similar results.
Heuer, Justus, Christoph Merkle and Martin Weber (2017): Fooled by Randomness: Investor Perception of Fund Manager Skill, Review of Finance, 21 (2): 605-635.
Abstract: Return-chasing investors almost exclusively consider top-performing funds for their investment decisions. When drawing conclusions about the managerial skill of these top performers, they tend to neglect fund volatility and the cross-sectional information contained in the number of funds and the distribution of skill. In multiple surveys of sophisticated retail investors, we show that they do not fully understand the role of chance in experimental samples of fund populations. Respondents evaluate each fund in isolation and do not sufficiently account for fund volatility. They confuse risk taking with manager skill and are thus likely to over-allocate capital to lucky past winners.
Merkle, Christoph, Daniel P. Egan and Greg B. Davies (2015): Investor happiness, Journal of Economic Psychology, 49: 167-186.
Abstract: We study investor happiness in a panel survey of brokerage clients at a 5UK6 bank. When investors anticipate future happiness, they set their return aspirations according to personal portfolio risk, objectives, investment horizon, confidence, and other individual characteristics. They are accurate in their forecasts, only rarely are investors unhappy with outcomes they predicted they would be happy with, and vice versa. However, determinants of experienced happiness only partially correspond to the ones found for anticipated happiness. In particular, relative performance plays an important role investors do not anticipate. Having outperformed other people contributes to investor happiness, as does active trading success.
Egan, Daniel P., Christoph Merkle and Martin Weber (2014): Second-order beliefs and the individual investor, Journal of Economic Behavior & Organization, 107, Part B: 652-666.
Abstract: In a panel survey of individual investors, we show that investors’ second-order beliefs—their beliefs about the return expectations of other investors—influence investment decisions. Investors who believe others hold more optimistic stock market expectations allocate more of their own portfolio to stocks even after controlling for their own risk and return expectations. However, second-order beliefs are inaccurate and exhibit several well-known psychological biases. We observe both the tendency of investors to believe that their own opinion is relatively more common among the population (false consensus) and that others who hold divergent beliefs are considered to be biased (bias blind spot).
Kempf, Alexander, Christoph Merkle and Alexandra Niessen-Ruenzi (2014): Low Risk and High Return – Affective Attitudes and Stock Market Expectations, European Financial Management, 20 (5): 995-1030.
Abstract: This experimental study investigates the impact of affective attitudes on risk and return estimates of stocks. Participants rate well-known blue-chip firms on an affective scale and forecast risk and return of the firms’ stock. We find that positive affective attitudes lead to a prediction of high return and low risk, while negative attitudes lead to a prediction of low return and high risk. This bias increases with participants’ confidence in their ratings and decreases with financial literacy. Firm characteristics such as a firm’s marketing expenditures and the strength of its brand have a positive impact on its affective rating.
Merkle, Christoph and Martin Weber (2014): Do investors put their money where their mouth is? Stock market expectations and investing behavior, Journal of Banking & Finance, 46 (9): 372-386.
Abstract: To understand how real investors use their beliefs and preferences in investing decisions, we examine a panel survey of self-directed online investors at a UK bank. The survey asks for return expectations, risk expectations, and risk tolerance of these investors in three-month intervals between 2008 and 2010. We combine the survey data with investors’ actual trading data and portfolio holdings. We find that investor beliefs have little predictive power for immediate trading behavior. The exception is a positive effect of increases in return expectation on buying activity. Portfolio risk levels and changes are more systematically related to return and risk expectations. In line with financial theory, risk taking increases with return expectations and decreases with risk expectations. In response to their expectations, investors also adjust the riskiness of assets they trade.
Merkle, Christoph and Martin Weber (2011): True overconfidence: The inability of rational information processing to account for apparent overconfidence, Organizational Behavior and Human Decision Processes, 116 (2): 262-271.
Abstract: The better-than-average effect describes the tendency of people to perceive their skills and virtues as being above average. We derive a new experimental paradigm to distinguish between two possible explanations for the effect, namely rational information processing and overconfidence. Experiment participants evaluate their relative position within the population by stating their complete belief distribution. This approach sidesteps recent methodology concerns associated with previous research. We find that people hold beliefs about their abilities in different domains and tasks which are inconsistent with rational information processing. Both on an aggregated and an individual level, they show considerable overplacement. We conclude that overconfidence is not only apparent overconfidence but rather the consequence of a psychological bias.