Stock market behavior

Stock market behavior, like other business decisions that individuals, small groups, and organizations make, is complicated by another social factor. Shefrin and Meir Statman (1985) argued that many investors lack the self-control necessary for sound investment decisions. As we just noted, people who own shares of a stock that is climbing often sell too early so they can enjoy the quick pleasure of making a profit. This tendency is easy to understand. But when people own stock that is falling, they often wait too long before selling in the hope that they might avoid a financial loss. Why do people continue to hang on in a failing situation—a decision- making disease that Shefrin (2006) calls “Get-Evenitis”? When the handwriting is on the wall, why compound the problem by throwing good money after bad?

In Too Much Invested to Quit, Alan Teger (1980) described a dollar-auction game that illustrates part of the dilemma. Imagine yourself in this situation: The auctioneer tells you and other participants that a $1 bill is about to be sold. As in a typical auction, the highest bidder will receive the dollar in exchange for the amount bid. Yet contrary to convention, the second-highest bidder must also pay the amount bid and will receive nothing in return. You and the other participants are asked not to communicate, and the minimum opening bid is set at five cents. Then, before you know it, the bidding begins. In laboratory experiments, two participants compete in the auction. They are supplied with a small amount of money that is theirs to keep, and they are free to quit the experiment at any time. What happens next might seem startling. Some pairs reasonably choose to take the money and run without making a single bid. Other pairs, however, get involved in escalating bidding wars. According to Teger, bidding for the dollar frequently climbs into the $5 range—more than the amount allocated for play by the experimenter. On one occasion, the auctioneer had to terminate the game after the two participants had bid $24.95 and $25!

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