Emotional responses to financial information

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A longstanding controversy in accounting and finance is whether financial markets are governed by rational forces or by emotional responses. The dominant view is that investors are rational and markets efficient and that, on average, there is no room for emotions. Despite the efforts of behavioural finance which challenges those assumptions, prior research based on archival or self-reported data has not opened the “black box” of the potential role of emotions in investors’ beliefs revision, a crucial intermediate between information and prices. To overcome this hurdle, we study the role of emotions as a complement to rationality in the decision-making process of traders by measuring their electrodermal response, a proxy for emotional response, during an experiment modeled on a simple but representative investment decision. This multi-trial within-subject experiment exposes each subject-trader to the announcement of earnings and to the revelation of the gain or loss on his investment decision. While controlling for other variables likely to affect a trader’s emotions, we find a statistically significant change in the emotional response of subject-traders when they are informed of their gains or losses. Furthermore, in line with Prospect theory, losses trigger a higher emotional response than gains. We also find that emotions moderate the “rational” relationship between unexpected earnings and excess stock returns. Our findings support behavioural finance view that investors are not fully rational and that emotions affect their belief revisions following new financial information.

Author(s):

Jean-François Gajewski    
University Savoie Mont-Blanc
France

Réal Labelle    
Stephen A. Jarislowsky Chair in governance, HEC Montréal
Canada

Li Li    
Montpellier Business School
France

Pierre-Majorique Leger    
HEC Montréal
Canada

Sylvain Senecal    
HEC Montréal
Canada