Congratulations to Professor Kelly Shue and her co-author Samuel Hartzmark, The University of Chicago, who were recently awarded the Exeter Prize 2019 for Research in Experimental Economics, Decision Theory and Behavioral Economics for their paper, “A Tough Act to Follow: Contrast Effects in Financial Markets,” published in The Journal of Finance.
The prize is awarded to the best paper published in the previous calendar year in a peer-reviewed journal in the fields of Experimental Economics, Decision Theory and Behavioural Economics and the committe acknowledged that this year was again exceptionally competitive with a large number of excellent nominations.About the paper, “A Tough Act to Follow: Contrast Effects in Financial Markets,” and why it was selected:
The paper provides evidence that contrast effects exist in an important real-world setting: Financial markets. The contrast effect has previously been shown to be a psychological bias that inversely distorts humans’ perception of information. That is, 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.