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Brayden

A hallmark of the behavioral economics agenda is to show that individuals’ economic behavior is often tainted by psychological biases that cause them to act in a less than rational manner. Because the behavioralists are interested in uncovering irrationality, their studies are usually pretty fun and intriguing (what could be more fun than irrationality?). A great example showed up in the latest issue of the Journal of Finance, “Sports Sentiment and Stock Returns (by Edmans, Garcia, and Norli). Motivating the study is the problem of whether investor sentiment, net of rational expectations of changes in asset values, shapes stock price changes. A great way to study this, it turns out, is to look at changes in the national stock market index on the day following a major international soccer loss (e.g. a World Cup loss). Here is a summary of their expectations:

Our null hypothesis is that stock markets are unaffected by the outcomes of soccer matches. This null hypothesis embeds the view that investors are rational, that markets are efficient, and that the economic benefits associated with winning an international soccer game are too small to influence the national stock market index. The alternative hypothesis is that wins lead to a positive stock market reaction and losses lead to a negative reaction. This is motivated by the findings from the psychology literature that suggest wins are associated with a good mood and losses with a bad mood.

The results overwhelmingly support the hypothesis that losses lead to a negative reaction. This latter hypothesis, of course, is a good test of the theory of investor sentiment given that sports losses tend to lead to a greater emotional reaction than wins. The study indicates that losses in World Cup elimination games elicit a stronger negative reaction than WC group games, which in turn lead to a larger reaction than losses in qualifying games. Losses also lead to larger negative reactions when there were pre-game expectations that the country’s team would win the match. The researchers also find no evidence that the stock market reactions are linked to any tangible changes in the economic outcomes of the country (e.g. consumers didn’t stop buying stuff after the loss). Thus, the results soundly support the idea that the stock market reactions were caused by a change in investor sentiment and not by some rational expectation of the market. All in all, this is a clever study with important implications for our understanding of the behavioral dynamics of the market.