SSRN-Do Behavioral Biases Adversely Affect the Macro-Economy? by George Korniotis, Alok Kumar

Talk about ambitious! Korniotis and Kumar apparently have found a link between behavioral finance and economic difference across different US States.

SSRN-Do Behavioral Biases Adversely Affect the Macro-Economy? by George Korniotis, Alok Kumar: "

This study investigates whether the adverse effects of investors' behavioral biases extend beyond the domain of financial markets to the broad macro-economy. Our results demonstrate that risk sharing (RS) levels are higher in U.S. states in which investors have higher cognitive abilities and exhibit weaker behavioral biases"

A few look-ins:

"examine whether the systematic effects of behavioral biases extend beyond the domain of financial markets to the aggregate macro economy. Specifically, we investigate whether behavioral frictions adversely affect the level of interstate risk sharing (i.e., state-level income smoothing) that can be achieved using financial markets. To our knowledge, this is the first paper that examines whether systematic behavioral biases can in‡fluence broader macro-economic indicators such as state-level risk sharing"

Looking at cognitive abilities:

"Because direct measures of cognitive abilities of stock market participants are not available, we use the demographic characteristics of the brokerage investors (e.g., income, education, age, social networks, etc.) to define a cognitive ability or “smartness” proxy for each investor and use these imputed cognitive ability measures to obtain aggregated state-level measures of cognitive abilities."

The findings? That behavioral finance does seem to impact economic measures.

"The average RS in states with less sophisticated investors (= 0.131) is less than half of the average RS in states with greater investor sophistication (= 0.324). Collectively, our evidence indicates that the aggregate behavioral biases of individual investors infl‡uence the level of risk sharing across the U.S. states."

Which partially explains the finding that state's risk sharing is quite different from state to state.

"For example, states such as Iowa, South Dakota and Kentucky achieve very low (less than 10%) levels of risk sharing using financial assets. In contrast, states such as Delaware, New Mexico and Oregon attain risk sharing levels of about 50%.""

Interesting! Which is at least consistent with the view that behavioral finance does influence the economy. Surely not the last word on this one.

Citation: Korniotis, George M. and Kumar, Alok,Do Behavioral Biases Adversely Affect the Macro-Economy? (August 12, 2008).
Available at SSRN: http://ssrn.com/abstract=1219304