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Even in joy there is always a tinge of sadness.7/30/20 version. This music score was submitted for Resonate 2024: An Open Access Call for Scores by the UCLA Music Library.

Biased information about the payoffs received by others can drive innovation, risk taking, and investment booms. We study this cultural phenomenon using a model based on two premises. The first is a tendency for large successes, and the actions that lead to them, to be more salient to onlookers than small successes or failures. The second premise is selection neglect-the failure of observers to adjust for biased observation. In our model, each firm in sequence chooses to adopt or to reject a project that has two possible payoffs, one positive and one negative. The probability of success is higher in the high state of the world than in the low state. Each firm observes the payoffs received by past adopters before making its decision, but there is a chance that an adopter's outcome will be censored, especially if the payoff was negative. Failure to account for biased censorship causes firms to become overly optimistic, leading to irrational booms in adoption. Booms may eventually collapse, or may last forever. We describe these effects as a form of cultural evolution, with adoption or rejection viewed as traits transmitted between firms. Evolution here is driven not only by differential copying of successful traits, but also by cognitive reasoning about which traits are more likely to succeed-quantified using the Price Equation to decompose the effects of mutation pressure and evolutionary selection. This account provides an explanation for investment booms, merger and initial public offering waves, and waves of technological innovation.

The thoughts and behaviors of financial market participants depend upon adopted cultural traits, including information signals, beliefs, strategies, and folk economic models. Financial traits compete to survive in the human population and are modified in the process of being transmitted from one agent to another. These cultural evolutionary processes shape market outcomes, which in turn feed back into the success of competing traits. This evolutionary system is studied in an emerging paradigm, social finance. In this paradigm, social transmission biases determine the evolution of financial traits in the investor population. It considers an enriched set of cultural traits, both selection on traits and mutation pressure, and market equilibrium at different frequencies. Other key ingredients of the paradigm include psychological bias, social network structure, information asymmetries, and institutional environment.

Human populations in many countries have undergone a phase of demographic transition, characterized by a major reduction in fertility at a time of increased resource availability. A key stylized fact is that the reduction in fertility is preceded by a reduction in mortality and a consequent increase in population density. Various theories have been proposed to account for the demographic transition process, including maladaptation, increased parental investment in fewer offspring, and cultural evolution. None of these approaches, including formal cultural evolutionary models of the demographic transitions, have addressed a possible direct causal relationship between a reduction in mortality and the subsequent decline in fertility. We provide mathematical models in which low mortality favours the cultural selection of low-fertility traits. This occurs because reduced mortality slows turnover in the model, which allows the cultural transmission advantage of low-fertility traits to outrace their reproductive disadvantage. For mortality to be a crucial determinant of outcome, a cultural transmission bias is required where slow reproducers exert higher social influence. Computer simulations of our models that allow for exogenous variation in the death rate can reproduce the central features of the demographic transition process, including substantial reductions in fertility within only one to three generations. A model assuming continuous evolution of reproduction rates through imitation errors predicts fertility to fall below replacement levels if death rates are sufficiently low. This can potentially explain the very low preferred family sizes in Western Europe.

This music score was submitted for the Kaleidoscope 2020 Call for Scores, an open access collaboration with the UCLA Music Library.

This music score was submitted for the Kaleidoscope 2020 Call for Scores, an open access collaboration with the UCLA Music Library.

This music score was submitted for the Kaleidoscope 2020 Call for Scores, an open access collaboration with the UCLA Music Library.

Psychological evidence indicates that decision quality declines after an extensive session of decision-making, a phenomenon known as decision fatigue. We study whether decision fatigue affects analysts’ judgments. Analysts cover multiple firms and often issue several forecasts in a single day. We find that forecast accuracy declines over the course of a day as the number of forecasts the analyst has already issued increases. Also consistent with decision fatigue, we find that the more forecasts an analyst issues, the higher the likelihood the analyst resorts to more heuristic decisions by herding more closely with the consensus forecast, self-herding (i.e., reissuing their own previous outstanding forecasts), and issuing a rounded forecast. Finally, we find that the stock market understands these effects and discounts for analyst decision fatigue.

Social learning is the updating of beliefs based on observation of others. Such observation can lead to efficient aggregation of information, but also to inaccurate decisions, fragility of mass behaviors, and, in the case of information cascades, to complete blockage of learning. We review the theory of information cascades and social learning and discuss important themes, insights, and applications of this literature as it has developed over the last 30 years. We also highlight open questions and promising directions for further theoretical and empirical exploration. (JEL D71, D82, D83, D91, Z13) [ABSTRACT FROM AUTHOR]

We propose that innovative originality is a valuable organizational resource and that owing to limited investor attention and skepticism of complexity, greater innovative originality may be undervalued. We find that firms' innovative originality strongly predicts higher, more persistent, and less volatile profitability and higher abnormal stock returns, findings that are robust to extensive controls. The return predictive power of innovative originality is stronger for firms with higher valuation uncertainty, lower investor attention, and greater sensitivity of future profitability to innovative originality. This evidence suggests that innovative originality acts as a "competitive moat" and is undervalued by the market.

In Chinese culture, certain digits are lucky and others unlucky.We test howsuch numerological superstition affects financial decision in the China initial public offering (IPO) market. We find that the frequency of lucky numerical stock listing codes exceeds what would be expected by chance. Also consistent with superstition effects, newly listed firms with lucky listing codes experience inferior post-IPO abnormal returns. Further tests suggest that our conclusions are not driven by endogeneity.

Evolved dispositions influence, but do not determine, how people think about economic problems. The evolutionary cognitive approach offers important insights but underweights the social transmission of ideas as a level of explanation. The need for a social explanation for the evolution of economic attitudes is evidenced, for example, by immense variations in folk-economic beliefs over time and across individuals.

We show that opportunistic insiders can be identified through the profitability of their trades prior to quarterly earnings announcements (QEAs) and that opportunistic trading is associated with various kinds of firm or managerial misconduct. A value-weighted trading strategy based on (not necessarily pre-QEA) trades of opportunistic insiders earns monthly four-factor alphas of over 1%, which is much higher than in past insider trading literature and substantial and significant even on the short side. Firms with opportunistic insiders have higher levels of earnings management, restatements, US Securities and Exchange Commission enforcement actions, shareholder litigation, and executive compensation. These findings suggest that opportunism is a domain-general trait.

Most applications of behavioral economics, finance, and accounting research to policy focus on alleviating the adverse effects of individuals' biases and cognitive constraints (e.g. through investor protection rules or nudges). We argue that it is equally important to understand how psychological bias can cause a collective dysfunction - bad accounting policy and financial regulation. We discuss here how psychological bias on the part of the designers of regulation and accounting policy (voters, regulators, politicians, media commentators, managers, users, auditors, and financial professionals) has helped shape existing regulation, and how an understanding of this process can improve regulation in the future. Regulatory ideologies are belief systems that have evolved and spread by virtue of their ability to recruit psychological biases. We examine how several psychological factors and social processes affect regulatory ideologies.

The review process for academic journals in economics has grown vastly more extensive over time. Journals demand more revisions, and papers have become bloated with numerous robustness checks and extensions. Even if the extra resulting revisions do on average lead to improved papers—a claim that is debatable—the cost is enormous. We argue that much of the time involved in these revisions is a waste of research effort. Another cause for concern is the level of disagreement amongst referees, a pattern that suggests a high level of arbitrariness in the review process. To identify and highlight what is going right and what is going wrong in the reviewing process, we wrote to a sample of former editors of the American Economic Review, the Journal of Political Economy, the Quarterly Journal of Economics, Econometrica, the Review of Economic Studies, and the Journal of Financial Economics, and asked them for their thoughts about what might improve the process. We found a rough consensus that referees for top journals in economics tend to make similar, correctable mistakes. The italicized quotations throughout this paper are drawn from our correspondence with these editors and our own experience. Their insights are consistent with our own experiences as editors at the Journal of Finance and the Review of Financial Studies. Our objective is to highlight these mistakes and provide a roadmap for how to avoid them.

Behavioral finance studies the application of psychology to finance, with a focus on individual-level cognitive biases. I describe here the sources of judgment and decision biases, how they affect trading and market prices, the role of arbitrage and flows of wealth between more rational and less rational investors, how firms exploit inefficient prices and incite misvaluation, and the effects of managerial judgment biases. There is a need for more theory and testing of the effects of feelings on financial decisions and aggregate outcomes. Especially, the time has come to move beyond behavioral finance to social finance, which studies the structure of social interactions, how financial ideas spread and evolve, and how social processes affect financial outcomes.

Financial analysts and stock market investors alike are subject to behavioral biases. Objective analyst forecasts can potentially help correct investor misperceptions. On the other hand, biased forecasts can reinforce or [...]

Introducing extrapolative bias into a standard production-based model with recursive preferences reconciles salient stylized facts about business cycles (low consumption volatility, high investment volatility relative to output) and financial markets (high equity premium, volatile stock returns, low and smooth risk-free rate) with plausible levels of risk aversion and intertemporal elasticity of substitution. Furthermore, the model captures return predictability based upon dividend yield, Q, and investment. Intuitively, extrapolative bias increases the variation in the wealth-consumption ratio, which is heavily priced under recursive preferences; adjustment costs decrease the covariance between marginal utility and asset returns. Empirical support for key implications of the model is also provided.

The last several decades have witnessed a shift away from a fully rational paradigm of financial markets toward one in which investor behavior is influenced by psychological biases. Two principal factors have contributed to this evolution: a body of evidence showing how psychological bias affects the behavior of economic actors; and an accumulation of evidence that is hard to reconcile with fully rational models of security market trading volumes and returns. In particular, asset markets exhibit trading volumes that are high, with individuals and asset managers trading aggressively, even when such trading results in high risk and low net returns. Moreover, asset prices display patterns of predictability that are difficult to reconcile with rational-expectations–based theories of price formation. In this paper, we discuss the role of overconfidence as an explanation for these patterns.

This paper examines whether the firm-level accrual and cash flow effects extend to the aggregate stock market. In sharp contrast to previous firm-level findings, aggregate accruals is a strong positive time series predictor of aggregate stock returns, and cash flows is a negative predictor. In addition, innovations in accruals are negatively contemporaneously correlated with aggregate returns, and innovations in cash flows are positively correlated with returns. These findings suggest that innovations in accruals and cash flows contain information about changes in discount rates, or that firms manage earnings in response to marketwide undervaluation. © 2008 Elsevier B.V. All rights reserved.