Does bias in the transmission process lead to overestimation of a strategy's value?

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The Ohio State University

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Investors are more likely to speak about their victories in the market as opposed to their defeats, and the listeners of this communication often do not fully discount for the biased sample they are presented. Moreover, if the receivers of this communication do not fully discount the message, it is possible they will overestimate the value of adopting the communicated strategy. Our study tested the presence, strength, and pattern of this bias in the transmission process. Participants in the study allocated a set amount of funds across different securities and had the opportunity to reallocate over multiple rounds. Different information was provided to the participants prior to allocation of the funds in each round. Participants received risk and return tradeoff information and transmissions of biased samples. We examined how the communications of biased samples affect the investment allocations of the participants. A rational economic participant would be expected to allocate most funds in the security with the highest risk and return tradeoff and continue to hold that allocation in the presence of the communications. We found that participants were subject to a transmission bias, causing them to overestimate the value of the biased samples and shift allocations to the securities with the highest transmitted returns. We can conclude individual investors are subject to a transmission bias in everyday interactions that can lead to suboptimal, irrational investment decisions that will cost them in lower returns.