STRATEGIES

Strategies: The link between risky driving and risky trading

If you get speeding tickets, watch out: The chances are good that you will also engage in possibly dangerous investing behavior, too. That is the implication of a new study that found that individuals who receive more speeding tickets tend to churn their portfolios.

The study, "Sensation Seeking, Overconfidence and Trading Activity," has been accepted for publication by The Journal of Finance. The authors are Mark Grinblatt, a finance professor at the University of California, Los Angeles, and Matti Keloharju, a finance professor at the Helsinki School of Economics. A version is at http://www.anderson.ucla.edu/documents/areas/fac/finance/06-06.pdf.

The professors were able to find a correlation between speeding tickets and trading frequency after they received access to several data sets of Finnish investors. Though the professors did not have access to the investors' identities, one of these databases contained details of speeding tickets issued between mid-1997 and the end of 2001 to residents of Helsinki and surrounding areas.

Another had information on the portfolios and trading records of all Finnish households from 1995 through 2002. The Finnish government also provided the professors with data on the incomes, age, marital status, gender, occupation and home ownership status of all those filing tax returns in 1998 and 1999.

These rich data sets enabled the professors to bracket other possible causes of trading activity and focus on the distinct influence of speeding tickets alone. They found that, other things being equal, an investor's portfolio turnover rate increased 11 percent for every additional speeding ticket he received. This is a surprisingly strong correlation, and is highly significant from a statistical point of view, according to the professors.

Grinblatt acknowledged that the propensity to speed did not remain constant throughout life. As people grow older, they are likely to become more conservative drivers - and, not coincidentally, to trade less often. But he stressed that he and his co-researcher controlled for factors like age when conducting their tests. So one way of interpreting their findings is that, between two people of the same age, the one who gets a speeding ticket is likely to have 11 percent more turnover in a portfolio.

Why would the tendency to speed be associated with more trading? One possible factor that the professors explored was overconfidence: If a driver deludes himself into thinking that he can avoid being caught when speeding, he may also delude himself into believing that he has above-average stock-picking ability.

After studying overconfidence, however, the professors concluded that it was not the source of the link. The professors found that while overconfident investors did tend to trade more, the trait was not correlated with their number of speeding tickets.

The professors' findings about overconfidence, along with those of other complex tests they had conducted, led them to conclude that thrill seeking was the primary cause of the correlation between speeding tickets and more frequent trading. This characteristic is present in people who seek out new and risky experiences purely for the fun of it. Thrill seekers trade more often not because they have an inflated belief that they can beat the market, according to the study, but because they find a static portfolio too boring.

Did the thrill seekers nevertheless improve their returns by trading often? No, the professors found. They found that the stocks the thrill seekers bought fared no better, on average, than those that they sold.

If anything, Grinblatt said, the thrill seekers were worse off after transaction costs were considered. They "cannot justify their trading in terms of their performance," he concluded.

The study provides yet more evidence that psychological motivations play a large role in investment decisions. The implication is that, before we initiate any trade, it is wise to engage in some honest self-reflection about our motivations. Are we trading because there is compelling evidence supporting it, or simply because we find our long-held stocks are not exciting enough?

Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch.

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