The ease of pronouncing the name of a company and its stock ticker
symbol influences how well that stock performs in the days immediately
after its initial public offering, two Princeton University
psychologists have found.
A new study of initial public
offerings (IPOs) on two major American stock exchanges shows that
people are more likely to purchase newly offered stocks that have
easily pronounced names than those that do not, according to
Princeton's Adam Alter and Danny Oppenheimer. The effect extends to the
ease with which the stock's ticker code, generally a few letters long,
can be pronounced -- indicating that, all else being equal, a stock
with the symbol BAL should outperform one with the symbol BDL in the
first few days of trading.
"This research shows that people
take mental shortcuts, even when it comes to their investments, when it
would seem that they would want to be most rational," said Oppenheimer,
an assistant professor of psychology. "These findings contribute to the notion that psychology has a great deal to contribute to economic theory."
Oppenheimer
and Alter, a graduate student in Oppenheimer's lab and the study's lead
author, will publish their work in the May 30 issue of the journal,
Proceedings of the National Academy of Sciences.
The two
researchers were initially looking for a different effect when they
stumbled upon the relationship between ease of pronounceability and
performance. They asked a group of students to estimate how well
a series of fabricated stocks would perform based only on the stocks’
names.
"We gave them the list of company names and
essentially asked, 'How well do you think the stock would perform?'"
Oppenheimer said. "At the time, we were primarily interested in
studying whether we could manipulate how people interpret the feeling
that information is easy to process. We weren't trying to study
markets or companies initially; stocks were just an interesting domain
of inquiry."
However, the relationship was very strong --
regardless of Alter and Oppenheimer’s attempts to manipulate students’
interpretations, the students still believed that the easily
pronounceable stocks would perform best.
When they noticed how
strongly name pronounceability influenced predictions of performance,
the researchers moved beyond the lab and investigated the relationship
between the variables in two large U.S. stock markets -- the New York Stock
Exchange and the American Exchange. The effect held in the real
world: the more "fluent" a stock’s name or symbol, the more likely the
stock was to perform well initially.
"We looked at intervals
of a day, a week, six months and a year after IPO," Alter said. "The
effect was strongest shortly after IPO. For example, if you started
with $1,000 and invested it in companies with the 10 most fluent names,
you would earn $333 more than you would have had you invested in the 10
with the least fluent."
Alter said the pair of scientists had been careful to address the possibility that other factors were at play in the study.
"We
thought it was possible that larger companies might both adopt more
fluent names and attract greater investment than smaller companies," he
said. "But the effect held regardless of company size. We also
showed that the effect held when we controlled for the influence of
industry, country of origin and other factors."
Oppenheimer
cautioned that while the findings might seem highly significant to the
investing public, they do not tell the whole story about how a stock
might perform after its IPO, nor are they reliable indicators of its
performance in the long run.
“Despite the implications of these
findings, investors as a group tend to correct themselves in the
presence of new information about how the markets operate," he said.
"You shouldn't make changes to your stock portfolio based on our
findings. The primary contribution of this paper is to add a
piece to the jigsaw of understanding how markets operate.”
What
the findings did offer, Oppenheimer said, was another piece of evidence
that markets -- and therefore the large groups of people who invest in
them -- are not the rationally-functioning entities that some experts
believe them to be.
"This is not the only factor that plays a
role in stock performance," he said. "A number of other economic and
psychological factors undoubtedly play a role as well. This study
does not argue that psychology is more important than economics, but
rather that one cannot ignore psychological variables when constructing
models of stock performance."
The research was funded by the National Science Foundation.
Abstract:
Predicting Short-Term Stock Fluctuations by Using Processing Fluency
Adam L. Alter and Daniel M. Oppenheimer
Three
studies investigated the impact of the psychological principle of
fluency — that people tend to prefer easily processed information — on
short term share price movements. In both a laboratory study and
an analysis of naturalistic real world stock market data, fluently
named stocks robustly outperformed stocks with disfluent names in the
short term. For example, in one study, an initial investment of
$1000 yielded a profit of $112 more after one day of trading for a
basket of fluently named shares than for a basket of disfluently named
shares. These results imply that simple, cognitive approaches to
modeling human behavior sometimes outperform more typical, complex
alternatives.
