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Loss Aversion and Incentives Omission Bias Evaluating Talent Momentum vs. Luck Loss Aversion and Incentives • In 4th down situations where (statistically) it’s better to go for it, NFL coaches punt/kick 96% of the time • There are some exceptions . . . • But didn’t used to be this way 2009 Patriots vs. Colts • 4th and 2 on own 28 yard line, up 34-28 *embed movie of play here* Deviating from convention can be risky • “My vocabulary is not big enough to describe the insanity of this decision”—Trent Dilfer, former NFL QB and ESPN analyst • “Ghastly . . . Too smart for his own good this time. The sin of hubris”—Dan Shaughnessy, Boston Globe • “Fourth-and-jack-ass. That’s our name for a nowinfamous play in New England Patriot’s history”— Pete Prisco, CBS Omission Bias (3 ball vs. 2 strike counts) Omission Bias (3-0 vs. 0-2 counts) Omission Bias • Super Bowl XLII: Giants vs. Patriots Omission Bias • 2009 U.S. Open Tennis Championship Omission Bias • 1993 NCAA Basketball Championship Michigan vs. NC *embed movie here* Evaluating Talent 1998 NFL Draft: Two “franchise” QBs Evaluating Talent Less than 10 years later . . . 1 Estimated Trade Value of Draft Picks 0 .2 .4 .6 .8 Top pick acquired (all possible) Picks exchanged for top pick (observed) 1 33 65 97 Overall Draft Pick 129 161 Evaluating Talent Early picks are very highly valued: #1 = #10+#11 = #29+#30+#31+#32 You have to pay about the same Does this match future performance? 14 .7 Probability “Better Than The Next Guy” 0 .1 .2 .3 .4 .5 .6 Average=.52 1 2 3 4 5 6 7 By draft round 15 Evaluating Talent is Risky • 9 of last 12 #1 picks have been QB’s Who Else Could You Have Had? = = + + a 3rd round pick Evaluating Talent in the NFL • What were the #1’s worth? 1x 6,000x 2x 1.5x 3x Evaluating Talent How do you hire and fire people? How confident are you in your ability to judge performance? The Myth of Momentum • Quiz #1: Which of the following is the best predictor? a) b) c) d) e) Performance over last 5 attempts Performance over last 5 games Performance over last month Performance over season Performance over multiple seasons The Myth of Momentum • Quiz #2: Heading into playoffs, which of the following is the best predictor of success? a) b) c) d) Performance in most recent game Performance in last week Performance in last month Performance over entire regular season Fooled by Randomness • Flip a coin 10 times . . . Which sequence is more likely to be random? 1. HTHTHTHTHT 2. HHHHHHHHHH 3. HHHTHHTTHT • Which Lotto number is more likely to win? 1. 99999 2. 13679 Damned Statistics • What does “4 out of his last 5” really mean? • Is a player 0 for 12 “due” to hit his 13th or doomed to miss it? • Situational or conditional statistics Momentum in Financial Markets Momentum is the phenomenon that stocks which have performed well in the past relative to other stocks (winners) continue to perform well in the future, and stocks that have performed relatively poorly (losers) continue to perform poorly. 24 24 Academic Discovery Fama and French: “…[T]he main embarrassment of the three-factor model, [is] its failure to capture the continuation of short-term returns documented by Jegadeesh and Titman and Asness…[T]he continuation anomaly exposes one of its shortcomings.” Asness Jegadeesh and Titman 1993 25 Asness, Moskowitz and Pedersen Moskowitz and Grinblatt Chan, Jegadeesh, and Lakonishok 1994 6 new working papers from AQR 1996 Grinblatt and Moskowitz 1999 2004 2008 2011 Historical Evidence from Academia Average Returns for Portfolios Grouped by Momentum 1927 – 2009 Annual Return in Subsequent 12 Months (%) 0.2 18.0% 0.15 13.6% 11.0% 9.7% 0.1 9.1% 6.0% 5.8% 0.05 3.2% 1.1% 0 -0.05 -4.5% -0.1 P1 20% of stocks with Worst Momentum P2 P3 Average Return of Each Quintile P4 P5 20% of stocks with Best Momentum Excess Return of Each Quintile* * Source: CRSP Database. Data is based on monthly returns from overlapping portfolios. Momentum is calculated by ranking stocks based on their past 12-month return excluding the most recent month. Returns are in excess of the beta-adjusted CRSP Value Weighted Index. Past performance is not an indication of future performance. 26 Momentum is the Fourth Factor Annualized Return (%) Since the mid-1990s, the standard for any asset pricing study is to adjust for 4 factors (betas): Size Value Momentum SmB Factor is a long-short portfolio composed of small stocks minus big stocks by market capitalization. HmL Factor is a long-short portfolio composed of stocks with high book to price valuations minus stocks with low book to price valuations. UmD is a long-short portfolio composed of stocks with positive momentum minus stocks with negative momentum by looking at the last twelve months price return excluding the last month. Past performance is not an indication of future performance. 27 27 Out of Sample Evidence • Small and large cap stocks • Industries • Bonds • Currencies • Index futures • Commodities • Corporate bonds • Emerging markets (all asset classes) • REITS Momentum in 58 Different Contracts Why? 1. Why does momentum exist in financial market prices, of all assets? 2. Why doesn’t momentum seem to exist in sports, all sports?