seems particularly appropriate for thinking about closed-end funds, and
also for Froot and Dabora’s evidence.
A second behavioral view of comovement was recently proposed by Bar-
beris and Shleifer (2003). They argue that to simplify the portfolio alloca-
tion process, many investors first group stocks into categories such as
small-cap stocks or automotive industry stocks, and then allocate funds
across these various categories. If these categories are also adopted by noise
traders, then as these traders move funds from one category to another, the
price pressure from their coordinated demand will induce common factors
in the returns of stocks that happen to be classified into the same category,
even if those stocks’ cash flows are largely uncorrelated. In particular, this
view predicts that when an asset is added to a category, it should begin to
comove more with that category than before.
Barberis, Shleifer, and Wurgler (2001) test this “category” view of co-
movement by taking a sample of stocks that have been added to the S&P
500, and computing the betas of these stocks with the S&P 500 both before
and after inclusion. Based on both univariate and multivariate regressions,
they show that upon inclusion, a stock’s beta with the S&P 500 rises signif-
icantly, as does the fraction of its variance that is explained by the S&P
500, while its beta with stocks outside the index falls.^33 This result does not
sit well with the cash-flow view of comovement—addition to the S&P 500
is not intended to carry any information about the covariance of a stock’s
cash flows with other stocks’ cash flows—but emerges naturally from a
model where prices are affected by category-level demand shocks.
- Application: Investor Behavior
Behavioral finance has also had some success in explaining how certain
groups of investors behave, and in particular, what kinds of portfolios
they choose to hold and how they trade over time. The goal here is less
controversial than in the previous three sections: it is simply to explain
the actions of certain investors, and not necessarily to claim that these ac-
tions also affect prices. Two factors make this type of research increas-
ingly important. First, now that the costs of entering the stock market
have fallen, more and more individuals are investing in equities. Second,
the worldwide trend toward defined contribution retirement savings plans,
and the possibility of individual accounts in social security systems mean
that individuals are more responsible for their own financial well-being in
retirement. It is therefore natural to ask how well they are handling these
tasks.
50 BARBERIS AND THALER
(^33) Similar results from univariate regressions can also be found in earlier work by Vijh
(1994).