Tuesday, August 09, 2005

Optimism and Economic Choice by Manju Puri, David Robinson

Puri and Robinson give us a new look at the old idea that optimism matters.

They identify optimists by looking at people's self-reported life expectancy. The findings are that not only do optimists work harder, but they buy more individual stock than their more pessimistic peers. .

SSRN-Optimism and Economic Choice by Manju Puri, David Robinson:

Short version:
"Optimists are more likely to believe that future economic conditions will improve. Self-employed respondents are more optimistic than regular wage earners. In general, more optimistic people work harder and anticipate longer age-adjusted work careers. They are more likely to remarry, conditional on divorce. In addition, they tilt their investment portfolios more toward individual stocks"

Longer version:

While I am usually quite interested in optimism research both in finance (e.g. Barber and O'Dean's work on excessive confidence leading to increased trading) and outside of finance (e.g. recovery from surgery etc), I confess I had not much seen much of the work cited. For instance:
"Gervais and Goldstein (2004) model how overconfidence in one's own ability leads to excessive effort, resolving moral hazard problems in teams. Rigotti, Ryan, and Vaithianathan(2004) develop a model in which optimists are more likely to embrace occupations with ambiguous returns, leading optimists to naturally choose entrepreneurship."
Puri and Robertson use self-reported life expectancy to proxy for optimism. That is, if the person expects to live for a longer time than actuarial tables suggest, that person is labeled an optimist. This rather simple labeling proves to be quite powerful.

For instance the authors report that:
"Our measure of optimism correlates with beliefs about future economic conditions. Respondents who report that they think economic conditions will improve over the next five years are statistically much more optimistic according to our measure than respondents who think conditions will stay the same or deteriorate."
And later:
"we findthat more optimistic people (regardless of their employment status) seem to view work more favorably: they work longer hours, they anticipate longer age-adjusted work careers, and they are more likely to think that they will never retire."
Which is all interesting, but I am not sure if I could include it in a FinanceProfessor blog (it would probably need to show up on my RandomTopics2 blog) but there is some pure finance in the paper:
"Optimists are more likely to own individual stocks, and they own a larger fraction of their equity wealth in individual stocks. Thus, they appear to be stock-pickers. This suggests that our measure of optimism captures the idea that optimists place greater weight on more positive outcomes than pessimists do. However, there is no evidence that more optimistic people tilt their portfolios more toward equity per se."
Very interesting.

Puri, Manju and Robinson, David T., "Optimism and Economic Choice" (May 2005). http://ssrn.com/abstract=686240


FinanceProfessor said...

Hi again,

Since it wasn't pure finance I decided to put the following in a comment rather than the body of the post:

As an aside, I could not help but think about Freidman's Flat World discussion of hope. If many in poor nations (here he focused on Islamic nations) where millions of people have given up hope, this finding would suggest that merely changing the rules may not be enough to spur economic development.

It also suggests the difficulty in helping the poor in any nation. Brutal honesty (“you are dirt poor and have no knowledge, no special abilities” etc) may not be strictly optimal. Building confidence (and optimism/hope) is also necessary. Indeed, any investment (be it financial or not) is at some level a sign of optimism. If not for optimism we would all live solely for today and invest zero.

I am not really sure where to go from here as too much confidence can be as bad as too little, but it is quite interesting to ponder.

any comments/ideas?

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