Can Individual Investors Beat the Market?

One of my favorite papers (mostly because of the academic honesty lacking in typical institutions).

Abstract (via SSRN)

We document strong persistence in the performance of trades of individual investors. The correlation of the risk-adjusted performance of an individual across sample periods is about 10 percent. Investors classified in the top performance decile in the first half of our sample subsequently outperform those in the bottom decile by about 8 percent per year. Strategies long in firms purchased by previously successful investors and short in firms purchased by previously unsuccessful investors earn abnormal returns of 5 basis points per day. These returns are not confined to small stocks nor to stocks in which the investors are likely to have inside information. Our results suggest that skillful individual investors exploit market inefficiencies to earn abnormal profits, above and beyond any profits available from well-known strategies based upon size, value, or momentum.
Findings (via SSRN)

Recent literature has emphasized that on average individual investors are misguided in their trades. We provide evidence here that some individual investors are persistently able to beat the market. Traders that can be classified among the top 10 percent (based on the performance of their other trades) buy stocks that earn abnormal returns of between 12 and 15 basis points per day during the following week. These findings are robust to different forms of risk adjustment, to the removal of small stocks from the sample, and to the removal of any firms in which the account has traded more than once. Similarly, there are also individual investors who consistently place underperforming trades. Traders classified among the bottom 10 percent of all traders place trades that can expect to lose up to 12 basis points per day during the subsequent week. In long horizon (holding period) returns, successful investors outperform unsuccessful investors by about eight percent per year. A trading strategy that exploits the information in investors’ trades earns risk-adjusted returns of about five basis points per day.

Finally, this evidence does not support the efficientmarket hypothesis. The ability of individual traders at a discount brokerage to select outperforming companies is not confined to small firms or to only a few firms in which the traders transact frequently; and some investors persistently trade so as to underperform. These findings suggest that investors’ persistent abnormal performance is not derived primarily from trading on inside information.

Click Here To Read: Can Individual Investors Beat the Market?

About Miguel Barbosa

I run this site.

12. March 2010 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

Leave a Reply

Required fields are marked *