Congratulations to one of Chicago Global’s Board of Advisors – Professor Samuel Hartzmark for winning the 2019 Exeter Prize for the best paper published in the previous calendar year in a peer-reviewed journal in the fields of Experimental Economics, Behavioural Economics and Decision Theory.
Sam and Kelly Shue (Yale) are winning the award for their paper titled “A Tough Act to Follow: Contrast Effects in Financial Markets” which documents that investors appear to compare a firm’s performance with the performance of a firm immediately preceding its own announcement, creating predictable returns.
From the announcement email, “The contrast effect has previously been shown to be a psychological bias that inversely distorts humans’ perception of information… individuals perceive signals as higher or lower than their true values, depending on what the recently observed signal was – even if that “benchmark” signal is actually irrelevant for the present evaluation.
While this bias has been demonstrated primarily in controlled laboratory environments, evidence from the field is more limited but available for individual decision making contexts of, for example, speed dating and consumer housing and commuting choices.
Hartzmark and Shue’s paper goes substantially further by providing evidence for the existence of contrast effects in the presence of typically disciplining arbitrage opportunities and expertise; that is, in sophisticated markets with professionals who make repeated investment decisions. Hartzmark and Shue show that contrast effects to preceding earnings’ announcements of oftentimes even irrelevant firms distort equilibrium prices and capital allocation.
Furthermore, they find that this costly mispricing effect reverses within approximately 50 trading days. Finally, the authors argue convincingly that this contrast effect likely biases perceptions of news rather than expectations. Together, Hartzmark and Shue’s paper demonstrates to us that markets may not be as efficient as economists typically assume: Prices react not only to the absolute content of information but are also prone to perceptional errors stemming from relative comparisons.”