Behavioral Finance: Bounded Rationality, "Irrational" Beliefs and "Non-Standard" Preferences
1. Price-Based Return Comovement (with T. Clifton Green), 2009, Journal of Financial Economics 93, 37-50.
"Investors appear to group companies based on their stock-price levels. This can cause excess-comovement."
We find that, shortly after a stock conducts a 2-for-1 split, the stock starts co-moving more with lower-priced stocks and less with higher-priced stocks. This shift in co-movement occurs after the effective date of the split and not on (or before) the announcement date of the split. Our results suggest that investors group companies based on their stock-price levels (even though, in finance, stock-price levels should not matter as a company can adjust its stock price to any level it wants through splits and reverse-splits). Our results also suggest that investors’ moving money in and out of categories induces stock-return co-movement above and beyond what would be expected based on firm fundamentals.
[Please check out the SAS code under "Code and Data" to reproduce our main results.]
2. Country-Specific Sentiment and Security Prices, 2011, Journal of Financial Economics 100, 382-401.
"Companies operating in less popular countries (among Americans) trade at a substantial discount in the US. Country popularity also affects foreign direct investment and cross-border mergers."
I provide evidence that a country’s popularity among Americans (as measured by Gallup Polls) affects US investors’ demand for securities tied to that country and causes security prices to deviate from their fundamental values. Country popularity also positively associates with the intensity of US cross-border M&A activity, suggesting that country popularity also enters the investment-decision-making process of firms.
[If you are interested in the country popularity data and your institution subscribes to the Gallup Polls or the iPoll Databank, please click here.]
3. IPOs as Lotteries: Skewness Preference and First-Day Returns (with T. Clifton Green), 2012, Management Science 58, 432-444.
"Investors appear to treat IPOs like lotteries. This can cause temporary IPO overpricing and poor long-run performance."
We find evidence that IPOs with greater upside potential have significantly higher returns on the first day of their trading; these IPOs also have noticeably lower long-term returns.
[Please check out the SAS code under "Code and Data" to reproduce our main results.]
4. Are Founder CEOs more Overconfident than Professional CEOs? Evidence from S&P 1500 Companies (with Hailiang Chen and Joon Mahn Lee), 2017, Strategic Management Journal 38, 751-769.
"Founder CEOs of S&P 1500 firms appear more confident (overconfident?) than their non-founder counterparts. Our finding may explain why large publicly traded firms managed by founder CEOs behave so differently."
We provide evidence that founder CEOs of large S&P 1500 companies are more overconfident than their non-founder counterparts (“professional CEOs”). We measure overconfidence via tone in CEO tweets, tone in CEO statements during earnings conference calls, management earnings forecasts, and CEO option-exercise behavior. We find that compared with professional CEOs, founder CEOs use more optimistic language on Twitter and during earnings conference calls. In addition, founder CEOs are more likely to issue earnings forecasts that are too high; they are also more likely to perceive their firms to be undervalued, as implied by their option-exercise behavior. To date, investors appear unaware of this “overconfidence bias” among founders.
[If you are interested in our founder dataset, which signs each CEO in the Execucomp database from 2008 through 2012 as a founder CEO versus a professional CEO, please click here.]
5. It Pays to Write Well (with Hugh Hoikwang Kim), 2017, Journal of Financial Economics 124, 373-394.
"Issuing financial disclosure documents that are difficult to read can cause firms to trade at a substantial discount."
Using a copy-editing software application that counts the pervasiveness of the most important ‘writing faults’ that make a document harder to read, our analysis provides evidence that issuing financial disclosure documents with low readability causes firms to trade at significant discounts relative to the value of their fundamentals.
[Please check out the STATA code under “Code and Data” to reproduce our main results.]
6. Why do Investors Like Short-Leg Securities? Evidence from a Textual Analysis of Buy Recommendations (with Hailiang Chen and Zhuozhen Peng), 2025, Review of Financial Studies (forthcoming).
"Our paper advocates for text-based methods as a complementary tool to investor surveys for extracting investor perceptions."
Our paper examines analyst reports and online stock opinion articles, which recommend that investors buy stocks that, based on prior literature, trade at comparatively high prices and earn low future returns (“short-leg securities”). We conduct textual analysis and test whether the justifications provided in these buy recommendations primarily (1) emphasize a stock’s safe-haven quality, (2) indicate general investor exuberance, or (3) highlight a stock’s lottery-like features. We find that the buy recommendations mostly emphasize stocks’ lottery-like characteristics. We subsequently validate our text-based inferences through a one-time survey of institutional investors and retail investors with long positions in short-leg securities. Overall, our results suggest that perceived upside potential plays a material role in explaining why investors invest in stocks that reside in short legs of anomalies.
[Please click here for the Online Appendix.]
Behavioral Finance: Market Frictions
7. Arbitrage Involvement and Security Prices (with Baixiao Liu and Wei Xu), 2019, Management Science 65, 2858-2875.
"The presence of a well-functioning shorting market can help correct under-pricing."
We propose that the presence of a deep and liquid short-selling market allows hedge funds to hedge their long positions, thereby allowing them to trade more aggressively on under-pricing and make markets more efficient. To test our proposition, we utilize the institutional feature in Hong Kong in virtue of which only stocks added to a special list can be shorted.
Our first-stage analysis uses hedge fund holdings data and provides evidence that the emergency of shortable securities, indeed, causes hedge funds to more aggressively buy seemingly underpriced stocks. Our second-stage analysis presents evidence that hedge funds’ increased involvement in these securities helps correct under-pricing and moves prices in the direction of fundamentals.
[Please click here for the Online Appendix.]
8. Offsetting Disagreement and Security Prices (with Shiyang Huang, Dong Lou and Chengxi Yin), 2020, Management Science 66, 3444-3465.
"We put forward that investors generally are less excited about portfolios than they are about individual companies and that this has important asset pricing implications."
We propose that investor beliefs frequently “cross” in the sense that an investor may like company A, but dislike company B, while another investor may like company B, but dislike company A. Belief-crossing makes it almost impossible to construct a portfolio that is comprised solely of every investor ’s most favorite companies. This causes the level of excitement for portfolios to be generally less than the levels of excitement that individual companies receive from their most fervent supporters. Coupled with short-sale constraints, wherein prices are set by the most optimistic investors, this causes portfolios to trade at discounts.
Utilizing various settings where the value of the portfolio and the values of the underlying components can be separately evaluated (e.g., closed-end funds), we present evidence supporting our proposition that, in financial markets, the “whole” is often less than the “sum of its parts.”
[Please click here for the Online Appendix.]
Social Finance (please click here for a repository of research in social finance)
9. It Pays to Have Friends (with Seoyoung Kim), 2009, Journal of Financial Economics 93, 138-158.
"Social ties between corporate directors and CEOs appear to affect directors’ monitory effectiveness."
The conventional view of director independence puts the focus on financial/familial ties to the CEO/firm. Here, we provide evidence that social ties between directors and CEOs also matter. We approximate social ties via background similarities (e.g., the CEO and the director both served in the military, share an alma mater, were born in the same region . . . ). We find that firms whose boards are conventionally and socially independent award a significantly lower level of compensation, exhibit stronger pay–performance sensitivity, and exhibit stronger turnover–performance sensitivity than firms whose boards are conventionally independent only.
10. Wisdom of Crowds: The Value of Stock Opinions Transmitted through Social Media (with Hailiang Chen, Prabuddha De and Yu (Jeffrey) Hu), 2014, Review of Financial Studies 27, 1367-1403.
"Stock opinions transmitted through social media can be very valuable."
This paper investigates the extent to which investor opinions transmitted through social media predict future stock returns and earnings surprises. We conduct textual analysis of articles published on one of the most popular social media platforms for investors in the United States from 2005 to 2012. We also consider the reader’s perspective as inferred via commentaries written in response to these articles. We find that the views expressed in both articles and commentaries predict future stock returns and earnings surprises in a statistically significant and economically meaningful way.
11. Information Sharing and Spillovers: Evidence from Financial Analysts (with Jose Liberti and Jason Sturgess), 2019, Management Science 65, 3624-3636.
"We suggest that “high-skill finance professionals” owe much of their success to the colleagues that surround them."
We study how information sharing within an organization affects individual performance in the finance sectors. We look at situations in which the same analyst, while working at the same broker, covers multiple mergers and acquisitions (M&As), in particular the acquirer prior to the M&A and the merged firm thereafter. We find that earnings forecasts for the merged firm are significantly more accurate when the analyst has a colleague (working at the same broker) covering the corresponding target prior to the M&A. This holds particularly true if acquirer- and target-analysts reside in the same locale, if they are part of a smaller team, and if the target-analyst is of higher quality. Our findings highlight the importance of information spillovers on individual performance in the financial sector.
12. The Rate of Communication (with Shiyang Huang and Dong Lou), 2021, Journal of Financial Economics 141, 533-550.
"We quantify how “contagious” financial news and opinions are."
We study the transmission of financial news and opinions through social interactions. We identify a series of plausibly exogenous shocks, which cause “treated investors” to trade abnormally. We then trace the “contagion” of abnormal trading activity from the treated investors to their neighbors and their neighbors’ neighbors. Coupled with methodology drawn from epidemiology, our setting allows us to estimate the rate of communication and how much such rate varies with characteristics of the underlying investor population.
[Please click here for the Online Appendix.]
13. Listening in on Investors’ Thoughts and Conversations (with Hailiang Chen), 2022, Journal of Financial Economics, 145, 426-444.
"We propose that investors’ natural desire to cast themselves in a favorable light can inadvertently lead to the propagation of noise."
A large body of literature in neuroscience and social psychology shows that humans are wired to be meticulous about how they are perceived by others. In this paper, we propose that such impression-management considerations can also end up guiding the content that investors transmit via word of mouth and inadvertently lead to the propagation of noise. We analyze server-log data from one of the largest investment-related websites in the United States, as well as experimental data. Consistent with our proposition, we find that investors more frequently share articles more suitable for impression management despite such articles less accurately predict returns. Additional analyses suggest that high levels of sharing can lead to overpricing.
[Please click here for the Online Appendix. Also, if you are interested in the Twitter data we use in our paper, please click here. The dataset contains for each PERMNO-Ticker/Day, the total number of tweets and the total number of retweets regarding the corresponding stock. The size of the dataset is roughly 200 MB.]
14. The Impact of Word-of-Mouth Communication on Investors’ Decisions and Asset Prices, 2023, Handbook of Financial Decision Making.
"A survey of the empirical literature on the presence and economic consequences of word-of-mouth communication among investors."
I review the empirical literature on word of mouth (WOM) among investors. I begin with an outline of the empirical challenges that WOM research faces and possible strategies for overcoming those challenges. I then discuss recent studies on WOM among retail and institutional investors. The research to date provides compelling evidence that WOM importantly determines investment decisions. On balance, the information transmitted through WOM does not appear to help investors make better investment decisions. I explore possible reasons. I also discuss potential asset-pricing implications, the emergence of social technologies, and possible avenues for future research.
15. Did the Game Stop for Hedge Funds? (with Jun Chen and Melvyn Teo), 2024.
"Retail investors increasingly use social media to coordinate and trade for ideological or strategic considerations."
We find evidence that public disclosures of hedge fund short positions attract retail investor activity on the social media platform WallStreetBets, driving up prices of heavily shorted stocks and often challenging institutional players. Further analyses suggest that hedge funds have begun to respond by reducing their short positions, leading to prolonged overpricing. Our findings point to the growing influence of retail investors in reshaping traditional market dynamics.
[Please click here for the Online Appendix.]
FinTech
16. The Use and Usefulness of Big Data in Finance: Evidence from Financial Analysts (with Feng Chi and Yaping Zheng), 2025, Management Science , 71, 4599-4621.
"Our study documents how our increasing reliance on big data and technology is reshaping the role of human labor in finance."
Alternative data have become a new source of information for investors. This paper examines how this development is reshaping the role of sell-side analysts. Employing textual analysis of analysts’ written reports, we show that analysts themselves have begun to adopt alternative data in their analyses. Furthermore, we find that when analysts report having drawn from alternative data, they generate more accurate earnings forecasts and their brokerages subsequently receive higher amounts in trading commissions from investors, suggesting that investors value the adoption of alternative data by analysts.
[Please click here for the Online Appendix.]
17. Tweeting Away Firm Value: How Investors Evaluate CEOs’ Use of Social Media (with Hailiang Chen, Baixiao Liu and Yi Tang), 2024.
"Occasional, business-focused social media use can improve communication with stakeholders, but excessive, off-topic activity risks damaging reputation and valuation."
This paper examines how investors react to CEOs’ personal use of social media and how these reactions affect firm valuation. We theorize two mechanisms: a corporate communication channel, in which work-related tweets enhance transparency and increase firm value, and a CEO distraction channel, in which non-work-related tweets reduce value by signaling distraction or self-promotion. Using a panel of S&P 1500 firms from 2006–2020, covering 248 CEOs and over 250,000 tweets, we find that Tobin’s Q rises with work-related tweeting volume but falls with non-work-related tweeting volume. These effects are moderated by information environment, CEO celebrity, and investor horizons. A supplementary survey of professional investors corroborates these mechanisms. Our results highlight social media’s dual role as both a communication tool and an agency cost.
[Please click here for the Online Appendix.]
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