Does it Pay to Pay Attention?

Alberto Rossi is Assistant Professor at the University of Maryland. This post is based on an article forthcoming in The Review of Financial Studies by Professor Rossi and Antonio Gargano, Senior Lecturer at The University of Melbourne.

Standard economic models assume that investors continuously process and incorporate all available information in their financial decisions. In reality, however, individual investors have limited information processing capacity and display limited attention. Rational economic models predict that attention-constrained investors should benefit from paying attention and should pay attention up to the point where the benefits of paying attention exceed the costs. On the other hand, a large body of behavioral literature shows that individual investors are subject to many behavioral biases and are prone to making investment mistakes. This literature suggests that paying attention may be harmful rather than beneficial to the investors.

While the literature is filled with theoretical frameworks studying the relation between attention and financial decisions, the literature is still lacking satisfactory answers to seemingly simple questions, such as, how often do investors pay attention to their investment portfolios? What type of individuals pay more or less attention to their finances? What stocks do investors tend to pay attention to? And, finally, is there a positive or negative relation between investor attention and investment performance?

We exploit a novel and unique brokerage account data set to answer these questions. For approximately 11,000 account holders, we have anonymized information—at the individual level—on investors’ logins to their brokerage account website. We also observe the pages each investor visits within the brokerage account domain and how much time is spent on each page. We use this data to construct various measures of attention at the individual investor level and combine it with clients’ trading activity and portfolio positions.

We first provide novel facts regarding investor attention. On average, investors log in to their investment account once a month, with some investors logging in virtually every day and some investors logging in only once a year. We explain this large heterogeneity in attention using investors’ observable characteristics. The most attentive investors have large investment portfolios and invest in small capitalization stocks, growth stocks and momentum stocks. On the other hand, investors that hold exchange-traded funds (ETFs) are less attentive. Finally, males pay more attention than females and financial attention increases with age.

Second, we study how investors allocate their attention. Investors research 31 stocks per year—on average—and focus on companies in the consumer-tech space. Among the top 20 researched tickers, we find tech giants such as Facebook and Apple ranked first and second, respectively. We also find Twitter, AT&T, Verizon, Tesla, Microsoft, Sirius XM, and Netflix. Among the top 20 tickers, we also find large conglomerates and banks, such as Bank of America, Ford, and General Electric. Finally, we find four ETFs: SPDR S&P 500 ETF, SPDR Gold Trust, SPDR Dow Jones ETF, and Market Vectors ETF. In terms of stock characteristics, investors pay more attention to companies with higher R&D expenditures, market-to-book ratios, market capitalization, and leverage, suggesting that investors prefer to research large companies that, while risky, have high growth potentials.

The second part of the paper studies the relation between attention and investment performance both at the portfolio and the individual trades level. At the portfolio level, we find a positive cross-sectional relation between attention and performance in that more attentive investors have higher risk-adjusted performance and portfolio Sharpe ratios, even after controlling for investment style. Our baseline results show that a standard-deviation increase in overall attention is associated with a 1.5% increase in annualized risk-adjusted returns and a 0.09 increase in investors’ annualized Sharpe ratios. These cross-sectional tests cannot distinguish whether certain investors perform better because they pay more attention against the alternative that investors pay more attention because their portfolio is performing better. To disentangle the two effects, we perform panel regression estimates that relate—at the individual portfolio level—changes in performance to changes in attention. Panel regressions have the additional advantage of allowing us to control for investor-specific skills using fixed effects and overall market conditions using time effects. At the one-month horizon, we find that a one-standard-deviation increase in attention is associated with an annualized increase in portfolio risk-adjusted performance of 0.38%. The effect increases to 0.62% at the two-month horizon and decreases slightly to 0.55% at the three-month horizon. This indicates that paying attention allows individual investors to improve their portfolio performance in the short term, suggesting that the improvement in performance hinges on attentive investors being able to purchase (sell) stocks that—in the short run—realize relatively large positive (negative) returns.

Because portfolio results may not capture investors’ active management decisions, we also relate attention to the performance of individual trades. Attention is positively related to the future performance of the stocks purchased up to four months after the trade is placed. At the three-month horizon, a unit-standard-deviation increase in attention increases the average annualized adjusted returns of the stocks purchased by 2.13%. We find—on the other hand—no discernible effect of attention on the performance of the stocks sold. To understand the underlying mechanism, we perform a number of auxiliary exercises. First, we show that the superior performance of high-attention investors arises because they purchase attention-grabbing stocks that have appreciated in the past and whose performance persists for up to six months. Second, we show that attention is particularly profitable when investors trade stocks with high uncertainty, but for which a lot of public information is available. Third, we show that Odean (1999)’s result that the stocks sold by individuals outperform the ones purchased disappears for high-attention trades, but is very strong for low-attention trades. For high-attention trades, the average annualized three-month abnormal return of the stocks purchased equals 3.16%, the one for the stocks sold equals 4.20%, and their difference is statistically insignificant. For low-attention trades, on the other hand, the average annualized three-month abnormal return of the stocks purchased equals −0.28%, the one for the stocks sold equals 3.08%, and their difference is statistically significant.

The complete article is available for download here.

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