The equity premium and its behavioral determinants, a new

The equity premium and its behavioral determinants, a new

 School of Economics, University of Economics, HCM Small Talks, Big Ideas June 25, 2015, Ho Chi Minh city Minh Hai Ngo, Faculty of Banking, UEH The equity premium and its behavioral determinants, a new approach Minh Hai Ngo & Marc Oliver Rieger (2014) 25/06/2015 The story •  Stocks are riskier than bonds/ Investors require a premium when invesRng into stocks, but… •  How large is the premium fundamentally? •  What can be the poten5al (behavioral) determinants beyond risk? •  This presenta,on: •  What is the equity premium, “fundamental” equity premium? •  Myopic Loss Aversion arguments and its failure in empirical tests •  Can Myopic Risk Preferences be an alternaRve? Minh Hai Ngo & Marc Oliver Rieger (2014) The story verview 2 O
5/06/2015 Overview •  Part 1: Historical ERP and MLA arguments from Benartzi & Thaler (1995) •  Myopia, Prospect Theory and Myopic Loss Aversion •  Part 2: Our fundamental ERPs, data and esRmaRon results •  Part 3: Data and methodology to test MLA hypothesis •  INTRA survey (Rieger et al, 2014) •  Regression models •  Part 4: Myopic Loss Aversion or Myopic Risk Preferences? •  Results & discussion Minh Hai Ngo & Marc Oliver Rieger (2014) Overview art 1 2 P5/06/2015 Part 1: The historical equity premium Mehra & Prescoa (1985) Minh Hai Ngo & Marc Oliver Rieger (2014) M&P 85’ ERP he historical 2 T5/06/2015 Part 1: The historical equity premium Minh Hai Ngo & Marc Oliver Rieger (2014) Historical ERP he story 2 T5/06/2015 Part 1: The historical equity premium Minh Hai Ngo & Marc Oliver Rieger (2014) The Puzzle esearch Qs 2 R5/06/2015 Research objecRves •  [Asset pricing] •  Do we have a good models? •  Do we integrate all the risk factors into the models? •  [Behavioral Finance] •  Do investors generally risk averse? •  Since risk aversion only fail to explain? What are the actual determinants? Minh Hai Ngo & Marc Oliver Rieger (2014) Research Os T95’ 2 B5/06/2015 Myopic Loss Aversion & the ERPs The Equity Risk Premium Puzzle Risk-­‐based ExplanaRons -­‐ Mehra & Prescoa [1985] -­‐  GEU, Habit FormaRon -­‐  Disastrous events, idiosyncraRc income shocks… -­‐  InsRtuRonal factors (borrowing constrains, tax, and liquidity limitaRons…) Minh Hai Ngo & Marc Oliver Rieger (2014) Behavioral ExplanaRons -­‐  Prospect theory (BT’93) -­‐  Disappointment aversion (Gul ’91)… -­‐  Ambiguity aversion (Chen & Epstein (2003) -­‐  Mental accounRng (Hens & Wöhrmann (2006))… -­‐  Myopic loss aversion (Benartzi and Thaler (1995), Barberis and Huang (2008)) MLA & ERPs rgument 2 A5/06/2015 Bernatzi & Thaler (1995) Myopic Loss Aversion can explain the equity premium puzzle •  Investors keep a long Rme vision are less sensiRve to recent market fluctuaRon. However, the majority is less paRent (i.e. Myopic) •  The more loss averse, the larger the required equity premium Myopic Minh Hai Ngo & Marc Oliver Rieger (2014) Loss aversion BT 95’ MLA T92’s CPT 2 K5/06/2015 Loss aversion in CPT Tvesky & Kanehman (1992) Minh Hai Ngo & Marc Oliver Rieger (2014) [TK92]’s CPT omponents 2 C5/06/2015 Myopia (Bernatzi & Thaler (1995)) Minh Hai Ngo & Marc Oliver Rieger (2014) Prospect yopia 2 M
5/06/2015 Myopia (Bernatzi & Thaler (1995)) Minh Hai Ngo & Marc Oliver Rieger (2014) Ivt. Hoz. his paper 2 T5/06/2015 Problem of the historical ERP •  Pros & Cons of the tradiRonal approaches in esRmaRng the ERPs Survey method -­‐ Ask directly the required -­‐  Natural, persuasive ERPs from objects -­‐  RepresentaRve (investors, scholars…) weakness & volaRle Ex ante esRmaRon -­‐ Discount future earnings -­‐  Based on hypothesized to get the current value of assumpRons ERPs Historical ERPs -­‐ Exclude the risk free -­‐  Simple, widely returns from stock returns accepted -­‐  Dispersion of results Minh Hai Ngo & Marc Oliver Rieger (2014) Beyond 2 …
5/06/2015 Problem of MLA •  Results only in calibraRon of historical ERP data in US (data mining) •  CPT parameters are pre-­‐determined, not (objecRve) esRmated Minh Hai Ngo & Marc Oliver Rieger (2014) Beyond 2 …
5/06/2015 Research quesRons •  Can we have a beGer es5ma5on of the equity premium? •  Yes, the “fundamental” esRmaRon based on IRR formula proposed by Fama & French (1999) •  Does the MLA s5ll survive? •  InternaRonal survey of CPT parameters from INTRA (Rieger et al, 2014) •  Empirical tests of ERPs on MLA variables •  Can Myopic Risk Preferences perform beaer? Minh Hai Ngo & Marc Oliver Rieger (2014) Research Os T95’ 2 B5/06/2015 Part 2: “Fundamental” ERPs •  Idea: •  TreaRng a firm as an investment project •  EsRmaRng ERPs by the internal rate of return formula •  Data •  N = 21,896 companies, 54 countries worldwide from the OSIRIS database (Bureau van Dijk Electronic Publishing) •  Period 2001 – 2010 with recession period 2007-­‐2008 included Minh Hai Ngo & Marc Oliver Rieger (2014) Fundamental 2 …
5/06/2015 “Fundamental” equity risk premium Table 1: Equity Risk Premium Estimation by IRRs Approach Worldwide
No. Country
Firms
Obs.
ERPs
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
Western Europe
Austria
Belgium
Switzerland
Cyprus
Germany
Denmark
Spain
Finland
France
United Kingdom
Greece
Ireland
Italia
Netherlands
Norway
Portugal
Sweden
Turkey
19
20
21
22
23
24
25
26
Argentina
Bermuda
Brazil
Chile
Cayman Islands
Mexico
Peru
Virgin Islands (British)
81
543
303
69
657
83
123
58
549
4057
1848
366
3793
518
737
194
4.66%
7.12%
6.35%
4.73%
13.82%
5.43%
5.54%
8.80%
27
28
North America
Canada
USA
2596
5727
13596
36089
1.50%
9.93%
1
58
•  54 countries worldwide 2
96
•  ERPs distribuRon 119
78
489
58
98
101
564
1075
200
50
197
98
98
38
265
228
468
705
847
360
3465
391
603
866
3976
6449
1303
336
1319
747
564
274
1604
1108
5.57%
5.88%
6.04%
7.23%
3.26%
0.94%
4.75%
5.83%
6.63%
6.30%
1.66%
6.98%
3.29%
7.75%
5.65%
1.46%
7.29%
5.16%
No. Country
29
30
31
32
33
34
Middle East
United Arab Emirates
Israel
Jordan
Kuwait
Oman
Saudi Arabia
Far East and Central Asia
•  Europe: Denmark: 0.94% ~ Netherlands: 7.75% 35
Bangladesh
Firms
Obs.
ERPs
35
364
121
90
92
70
217
1896
892
556
719
442
11.86%
5.68%
4.14%
11.21%
8.19%
8.98%
36
37
38
39
40
41
42
43
44
45
46
47
48
49
China
Hong Kong
Indonesia
India
Japan
Korea (South)
Sri Lanka
Malaysia
Philippines
Pakistan
Singapore
Thailand
Taiwan
Vietnam
99
2236
123
72
2756
2435
1288
158
672
126
347
527
409
1413
155
294
14548
856
278
14583
17769
8143
835
4865
713
1697
3256
2771
9104
417
10.20%
6.36%
7.34%
3.04%
5.01%
3.02%
7.48%
7.14%
5.48%
6.79%
6.16%
9.02%
7.78%
6.86%
15.06%
50
51
52
53
54
Africa
Egypt
Kenya
Morocco
Nigeria
South Africa
154
34
34
84
212
1065
181
233
399
1366
13.77%
12.23%
9.55%
11.25%
16.33%
•  America: ArgenRna: 4.46% ~ USA: 9.93% ~ Cayman Islands: 13.82% •  Middle East: Jordan: 4.14% ~ United Arab Emirates: 11.86% •  South
Asia: Indonesia: 3.04% ~ Vietnam: 15.06% and Central America
•  Africa: Morocco: 9.55% ~ South Africa: 16.33% Minh Hai Ngo & Marc Oliver Rieger (2014) Fundamental art 2 2 P5/06/2015 Part 3: Data & Methods to test MLA + Cross-sectionally: Stocks that catch eyes
+ Inter-temporally: more weights on current earnings
+ Investors are averse towards losses
+ A loss looms larger than a gain (Prospect Theory)
The higher the aversion to losses and the more frequently investors inves,gate their por9olio, the higher the equity risk premium Minh Hai Ngo & Marc Oliver Rieger (2014) Argument arameters 2 P5/06/2015 INTRA survey & MLA Parameters •  INTRA survey •  Loaery-­‐type quesRons to esRmate the risk avtudes of investors worldwide with 6,912 subjects in 53 countries •  What can be expected? Rieger, Wang and Hens (MulRnaRonal Finance Journal, to appear) •  Country-­‐level •  Historical ERPs Risk Aversion Risk Seeking Loss Aversion Pa,ent + + + -­‐ ERPs •  27 countries Minh Hai Ngo & Marc Oliver Rieger (2014) Parameters egressions 2 R5/06/2015 INTRA survey & MLA Parameters •  α and β are esRmated from pure-­‐gain loaeries while γ and δ are from pure -­‐loss ones. •  θ : Neutral loss aversion parameter (Tversky and Kahneman (1992)) Risk Aversion Risk Seeking Loss Aversion Pa,ent + + + -­‐ ERPs Minh Hai Ngo & Marc Oliver Rieger (2014) Parameters egressions 2 R5/06/2015 MLA Parameters from INTRA Minh Hai Ngo & Marc Oliver Rieger (2014) Parameters 2 5/06/2015 sults and Discussion
Models & Results equity risk premium and the p
ction,Regression we investigate
the relations
between
myopic loss aversion theory. Econometrically, we imply the following we
:
•  We apply the following weighted regression models: wi ERP i,j =
i
+ wi Mi ⇥1i + wi Ci ⇥2i + ⇤i , (7)
RPi,j is the equity risk premium of firm in ccountry
ountry i, Mi,
a is a ve
i is M
ERPi,j w
ishere: the Eequity
risk
premium
of firm
j j in
i
vector of variables of interest, Ci is a vand
ector risk
of controls of interest
(myopic
theory
parameters
preferences
or the combi
variables ose). •  CControl i is the vector of control variables, w i is the weighting variable
Firm most lto
ikely the equity risk sample. M
e inverse • rate
oflevel thecharacterisRcs possibility wofhich a firm
beaffect present
in the
(beta, of
volaRlity, leverage of
raRo, analysis, pin
ast areturns) over th
the weightpremium is the ratio
the number
companies
country
•  Cin
ountry ggregated ⇤fiactors categories) f companies
the asample,
is the (6 error
term. Minh Hai Ngo & Marc Oliver Rieger (2014) Regressions yper & Loss 2 h5/06/2015 Part 4: ERPs, PaRence and Loss Aversion + controls
Minh Hai Ngo & Marc Oliver Rieger (2014) hyper & loss sk & Loss 2 R5/06/2015 Part 4: Myopic Risk Preferences + Investors are nowadays less patient
+ Are investors ACTUALLY averse towards losses?
+ Risk averse in gains (Common knowledge)
+ Risk-seeking in losses (INTRA)
Myopic loss aversion only fails/ Other behavioral determinants have to be considered Minh Hai Ngo & Marc Oliver Rieger (2014) Argument arameters 2 P5/06/2015 Part 4: ERPs, Myopic Risk Preferences + controls
Minh Hai Ngo & Marc Oliver Rieger (2014) Risk & loss obustness 2 R5/06/2015 Myopic Risk Preferences & Macro. Econs. Minh Hai Ngo & Marc Oliver Rieger (2014) Robustness 2 …
5/06/2015 Culture dimensions of MRP and ERPs Minh Hai Ngo & Marc Oliver Rieger (2014) Robustness onclusions 2 C5/06/2015 Conclusions •  ContribuRon to the literature •  The first paper which esRmates firm-­‐level “fundamental” values of the equity risk premium •  Rigorous empirical tests of potenRally behavioral determinants of the equity premium puzzle •  Open research quesRons •  Myopic Loss Aversion (MLA) or Myopic Risk Preferences (MRP)? Minh Hai Ngo & Marc Oliver Rieger (2014) Conclusions &As 2 Q5/06/2015 Minh Hai Ngo & Marc Oliver Rieger (2014) Q&As nd 2 E5/06/2015 Minh Hai Ngo & Marc Oliver Rieger (2014) Ends ackups 2 B5/06/2015 CumulaRve Prospect Theory Tvesky & Kanehman (1992) Minh Hai Ngo & Marc Oliver Rieger (2014) Prospect 2 …
5/06/2015 CumulaRve Prospect Theory Minh Hai Ngo & Marc Oliver Rieger (2014) CPT Components M
yopia 25/06/2015 and in nominal values, because investors usually form their decisions based on reports of
firms and investment funds, which are in nominal values (Benartzi and Thaler (1993)).
Additionally, we use book value in our estimation with the asumption that our results
capture better the “real” returns from the actual investment in the company, excluding
some risks from trading in stock exchanges. Mathematically, the IRRs on costs are the
discount rates rc that solve
IRR formula for esRmaRng EPRs IC0 =
Xt It
(1 rc )t
+
(F SCt +Xt ) (F BCt +It )
(1 rc )t
+
F CT
(1 rc )T
, (2)
where
IC0 : initial book value of a firm in the beginning of the IRRs estimation period,
Xt : cash earnings of the firm in year t,
It : gross investment of the firm in year t,
F SCt - firm sold at cost: terminal book value of the firm at the end of the investment
sub-period,
F BCt - firm bought at cost: book value of the firm at the beginning of the investment
sub-period,
F CT : book value of firm at the end of the IRRs estimation period.
The formula (2) is the standard expression of IRRs for an investment project. We
introduce F SCt and F BCt for capturing the terminal value of the investment for at least
two consecutive years within the investigation period. The middle part of formula
(2)
IRRs formula book can H
beai interpred
as the
value
of the
following
at
Minh Ngo & Marc Oliver Rieger (2014) investment:
we
buy
the
company
2 …
5/06/2015 “Fundamental” equity risk premium Minh Hai Ngo & Marc Oliver Rieger (2014) Fundamental 2 …
5/06/2015