When talking about finance or economics, it’s not exactly novel to point out that not everybody behaves rationally. Although awareness of these behavioral influences within financial markets has been around at least in academia for some time, the field continues to bring forth new research that highlights the extent of the effect of these behavioral factors on investing.
In a paper published in September, and in this quarter’s issue of the Journal of Behavioral Finance, researchers Andreas Oehler, Stefan Wendt, Florian Wedlich, and Matthias Horn present research on individual personality and financial decision making.
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In the study, a questionnaire was given to 364 undergraduate finance students that measured their degree of extraversion and neuroticism. The students then participated in an experimental asset market. The study went on to show that more extraverted individuals pay more for financial assets and also buy more of them when they are overpriced. More neurotic individuals, on the other hand, tend to hold less risky assets in their portfolio, and also sell financial assets at lower prices.
The authors describe an experimental asset market as, “designed to examine informational efficiency, detect allegedly irrational behavior as a cause of price bubbles and crashes, and identify factors that influence price deviations from fundamental values, or to reveal behavioral biases, such as the disposition effect or overconfidence.” They went on to point out that individual personality has hardly been integrated into studies that apply experimental asset markets.
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Extraversion and Neuroticism
Based on existing psychology literature, extraverted individuals tend to be more optimistic, excitement seeking, and active. They also tend to pay more attention to positive information and less attention to the negative news. Prior research has shown that extraverted individuals tend to be more optimistic about their ability to repay debts. In the 1967 book, The Biological Basis of Personality, author HJ Eysenck describes the risk-taking behavior of extroverted individuals as an attempt to raise their state of arousal. Since these individuals seem to be “chronically under-aroused” they accept higher degrees of risk to reach their optimal level of arousal. Additional research has also found these individuals to express higher levels of overconfidence than those less extroverted.
On the other end of the spectrum, individuals with a high degree of neuroticism tend to be more pessimistic. They also exhibit more fear of uncertainty and ambiguity. In 2014, Pawel Niszczota found individuals from countries with higher scores of neuroticism, invest less in foreign equities and foreign debt, which are traditionally assets bearing more uncertainty.
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Implications
Oehler et al. found the effects of extraversion and neuroticism to remain present even after controlling for gender, which can often be a factor in studies regarding either personality or investment decisions. In the paper, the researchers offered suggestions for how professionals can apply their findings to the investment landscape:
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“Financial service providers might consider offering more personalized financial advice to reflect that, for example, investors with high values in neuroticism prefer less risky portfolios than less neurotic investors do. This can help financial service providers to obey the Markets in Financial Instruments Directive (MiFID), which requires that, for example, individuals’ ability to bear losses and their investment objectives including their risk tolerance be taken into account. In this sense, assessing personality traits can give hints concerning risk preferences and risk profile.”
They also proposed a potential benefit to research regarding bubbles in financial markets, by recognizing the influence of personality as an explanatory factor.
