All that Glitters: The effect of Attention and news on the Buying Behavior of Individual and Institutional Investors

Abstract

Attention is a scarce resource. When there are many alternatives, choices that attract attention are more likely to be chosen. If the salient attributes of a choice are critical to our utility, attention serves us well. If not, attention may lead to suboptimal choices. In this chapter, we test the proposition that individual investors are more likely to buy, rather than sell, those stocks that catch their attention. We posit that this is so because attention affects buying behavior more than selling. When choosing which common stocks to buy, investors face a huge search problem. There are thousands of possibilities. It is impossible-without the aid of a computer-for most investors to evaluate the merits of every available common stock. When selling, however, most investors consider only stocks they already own. These are typically few in number and can be considered one by one. While each investor does not buy every single stock that grabs his attention, individual investors are more likely to buy attention-grabbing stocks than to sell them. In contrast, institutional investors have more resources with which to search for stocks. Furthermore, the search for stocks to purchase and stocks to sell is more symmetrical for institutional investors because they hold large portfolios from which to sell and they often sell short. We look at three proxies for how likely stocks are to catch investors' attention: daily abnormal trading volume, daily returns, and daily news. We calculate net buy-sell imbalances for more than 66,000 individual investors with accounts at a large discount brokerage, 647,000 individual investors with accounts at a large retail brokerage, 14,000 individual investor accounts at a small discount brokerage, and 43 professional money managers. Individual investors tend to be net purchasers of stocks on high-attention days-days that those stocks experience high abnormal trading volume, days following extreme price moves, and days on which stocks are in the news. Institutional investors are more likely to be net buyers on days with low abnormal trading volume than on those with high abnormal trading volume. Their reaction to extreme price moves depends on their investment style. We present empirical evidence that the collective tendency of individual investors to more aggressively buy than sell attention-grabbing stocks leads to poor subsequent returns for aggressively purchased stocks. © 2011 John Wiley & Sons Ltd.