Investors Rationality for IPOs Using Meta Analysis and Forest Plots in Neyeloff et al. (2012) Framework: An Investigation

Introduction

The goal of this article is to study the contours of individual investors’ behaviour as regard to the initial public offering (IPO) issues. The attitude of the individual investor may be influenced by the different investment goals like risk and return level, time period and performance aspects of the security. Most of the time, the investors’ represent as rationally and count the present available information in the decision-making process. It is difficult to say that one rational decision is correct for the one investor, simultaneously may not be appropriate for the other investor. The concept of behavioural finance helps to understand that how the minds of the investors’ works. Sometimes, the investors make optimistic decisions when seems in the good mood otherwise behave underperformed. The investors’ rationality means the use of thinking to understand the investment decisions of the investors and to avoid the influence of the most negative investing emotions. The more the risk is involved in an investment, at the same time the more the return is required to motivate the investors. The investors undertake the risk with the expectation of getting rewarded in every sphere of the investment decision making. If the investors are suffered loss in the past then it is difficult to formulate the new investments very soon because of the fear of risk. Even the smartest to smartest investor also trap into the losses and gains while trading because of their overconfident behaviour. To maintain the money balance in the stock market is to select the accurate combination of securities and diversify the risk into different portfolios.

Every individual investors behave differently in the different market situations but the market wants to know the pulse of an investor that how the investor perceives and responds to the market. So the study must be made for evaluating the behavioural aspects of the investor such that the market can know the pulse of an investor. This step is helpful for the stock brokers, portfolio managers so that it is easy for the market to offer better stocks to the investors. The investors who buy the IPO shares on more positive information and wants to sell it at the price of stock goes increases otherwise hold and wait until the share prices come up to increase. If the investors behave irrationally while making investment decisions, it causes the loss for the investor. The rational decision maker demands technical knowledge and personal experience for the selection of the accurate portfolio securities. There is no perfect method to predict the prices of any stock accurately which helps in taking the decision of buying and selling stocks. There is no particular rule that can implement to understand how the investors behave in that certain moment. Thus, it is important to consider the psychological biases to identify the behaviour of the investors. This study covers the following behavioural contours that affect the investors’ decision making.

The overconfidence bias is one of the psychological biases where the investors believe that they are confident about their own investments’ opinions, judgements and aggressively trade which causes to make wrong decisions. These investors are in the mental illusions that they can control the uncontrollable events also. The disposition effect is the propensity of the investors to sell the winning investment too early and maintain the falling investments too long. The conservative bias is another aspect of the behavioural contours in which the investors are very slow to pick up on the new available information of buying and selling of the stock and behave pessimistically. In the mental accounting, the investors look at the big picture and divide their money into separate purposes in their minds rather than the use of money for single purpose. The another behavioural contour the cognitive dissonance describes that the investors feel uncomfortable while choosing the portfolios, which one is accept or reject and hold two contradictory ideas in their mind simultaneously. Herding is also the psychological bias where the investors are follow the signals of the others, that means if the majority of the investors starts moving in one direction then the other investors’ also imitate to feel safer. The investors also experience through regret when they realise that their decision of buying securities is proved wrong decision and if they taking another decision that proved a better decision.

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Figure 1.

Source: Chin (2012).

Review of Literature

In order to study the behaviour of investor, the previous studies were done to develop the concept and to understand the contours of investors’ behaviour in the IPO markets and understand what had been done earlier. This study investigated the investors’ behaviour with the help of different behavioural finance theories, namely, overconfidence, disposition effect, conservatism, mental accounting, cognitive dissonance, herding and regret theory used to understand the investors’ behaviour. Kaheman and Tversky (1972) oriented the prospect theory which recognised the willingness of investors to invest. This willingness was segmented into two different parts: first was editing them which defined how the IPO stock will perform and second was the judgement principle which is defined as measurement of the profit and loss. Bondt and Thaler (1985) demonstrated that the people consistently exaggerated to the anticipated and dramatic news events, which resulted in the stock market’s worst form of inefficiencies. Odean (1998; 1999), Zaiane and Abaoub (2010) and Tehrani and Gharehkoolchian (2012) found that people tend to be overestimate their knowledge, and underestimate the risks, skills and the precision of information. Men were perceived to be more confident than women in beating the market. The overconfident investors were caused to overtrading.

Barberis and Thaler (2002) and Ritter (2003) provided the information of behavioural finance. The behavioural finance was gathered with the orthodox premises of expected utility maximisation with rational investors in efficient markets and this behavioural finance was divided into two parts which were cognitive psychology interpreted as how investor think and the limits to arbitrage referred to when the markets would be efficient. Glaser and Weber (2007) concluded that the overconfident investors made more trade than the rational investors. Shefrin (2007) said that the excessive optimism behaviour of investors was concerned with the excess approximation of the adverse outcomes with comparison to the positive ones. The overconfidence was pertained that how people understood their own achievements and the skills to perform. Bondt and Thaler (1985), Chun and Ming (2009), Chandra and Kumar (2010), Zaiane and Abaoub (2010), Lin (2011), Murthy and Joshi (2012), Sahni (2012) and Adetiloye and Babajide (2012) said that the investors had overconfidence in the accuracy of their own judgements. It was the propensity to place an irrational overconfidence in one’s possession of the qualities and feelings. The overconfident investors overestimated the private information and neglected the available information. The overconfident investors were avoided the Baye’s rule and in the illusion that, ‘I am right’. The overconfident investors were optimistic in nature and believe that they had investing power and knowledge to understand the latest market trends or capability to choose the coming high demand stocks. The overconfidence resulted in excess trading. The traders believed that they were superior than others for selecting the better stocks at appropriate times to come and to going out at a correct time. Zoghlami and Matoussi (2009) illustrated that the overconfidence tendency had no significant impact on the Tunisian investors. Chandra and Kumar (2010) suggested that the overconfidence had insignificant effect on the Indian investors with their investing decisions. Zaidi and Tauni (2012) showed the optimistic relationship between the overconfidence and personality traits as agreeableness, extroversion and consciousness but the pessimistic with neuroticism trait. Due to the overconfidence bias, people overestimated the knowledge, underestimated the risk and exaggerated the ability to control events.

Odean (1998) demonstrated the disposition effect that kept the diminishing investment too long and sold gaining investment too soon by analysing the trading accounts and the trading patterns. Chen et al. (2007) found that Chinese investors were inclined towards a disposition effect. The investors were more liable in acceptance of the paper gains than the paper losses. The paper loss defined as when the investors acquire the stock and that stock declined subsequently, and then it was referred as the paper loss. The disposition effect was appeared to be stronger in Chinese investors. Lin (2011), Murthy and Joshi (2012), Sahni (2012) and Tehrani and Gharehkoolchian (2012) told about the disposition behaviour of the investors to restrain too long the loser stocks and sold the profitable stock too early. The investors rationally or irrationally believed that the current losers will outperform the current winners at coming time. Murthy and Joshi (2012) documented that investors were totally supported by the disposition effect theory. The investors demonstrated the disposition effect by hold losing investment too long and sold winning investment soon.

Ritter (2003) showed that with the variability of market, people were not quickly ready in adapting the changes. When the market changed, people under reacted due to the conservative bias and overreacted to the representative bias. Chen et al. (2007) collected the results from the Taiwanese market in which people who under reacted to the earning announcements were described on the scale of conservative bias and showed the optimistic behaviour of the investors. Chandra and Kumar (2010) and Murthy and Joshi (2012) documented the conservative attitude of the investors; investors were too slow to update a belief in response to the recent evidence. The conservatism bias was at war with the representative bias. When the things were changed, people might under react because of the conservative bias. Chandra and Kumar (2010) and Sahni (2012) explained the representative behaviour of the investor that the investors were investing on the basis of their past experience. This included into the heuristics theory in which people had the propensity to have decisions or make assessment depends on the present available information. This lead to develop a rule of thumb, but it was not always correct. The heuristics caused investors commit errors in particular situations. The investors considered the recent past performance of any stock for its near future performance of stock in the representative bias.

Murthy and Joshi (2012) and Sahni (2012) demonstrated the cognitive dissonance in which individuals try to reduce conflict by changing their past values, feelings and opinions. This theory was connected with the investor’s psychology. It was the cognitive state when beliefs and assumptions seem wrong and it was a sort of pain of regret. If the feeling was of regret, the person claimed someone else to be responsible for this unwanted outcome. The herding behaviour meant that the impulsive mental thinking of an investors responding to the signals from others. Lin (2011) demonstrated the positive impact of the herding and the females were more prone to herding than the males. Herding behaviour in which investors blindly followed the decisions of others rather than believing on the rational thinking. This behaviour was occurred frequently in everyday decisions based on the copying behaviour of others. In the case of herding behaviour, the mentality of the individual investor was just similar as the majority of people performed around them as the poor investment decision making and the lack in the trait of thinking. Sahni (2012) found that the investors were taken the risk unless fallen into the situation of losses. The investors preferred to reserve on to the loosing stock with the desire that the price will increase.

Regret theory means the investor regrets when their investment decisions perform at a lower level and other investment alternatives produce the better outcomes. Shefrin (2009) found that the investors regretted when the investors sold winners stock too early and holding on to the losers stock. Chandra and Kumar (2010), Murthy and Joshi (2012) and Tehrani and Gharehkoolchian (2012) described the regret theory which expressed the emotional reaction of people’s experience after realising that they had made an error in judgement. The regret aversion arose when investors’ decisions turned out to be wrong even if the available information appears correct. The investors wanted to avoid the pain which came from the poor investment decision. This aversion encouraged the investors to hold the poor performing stock for sale activity until the profit was made.

In the aforementioned review of literature, many researchers and scholars were given their own experiences, interpretations and explanations about the behavioural finance theories of the investors’ rationality. The most difficult challenge faced in the area of investment decisions. An optimum investment decision played an active and important role in the IPO market.

Objective and Research Methodology

This article focuses on to understand the contours of the investors’ rationality as regards to their investment decisions in the initial public offering. Keeping this into consideration, it was hypothesised as:

H0: Investors Are Rational

This hypothesis depends on the calculated value of chi-square with respect to the significance level. In this research article, the questionnaire based 20 studies have been selected through Google browser under the period 2001 to 2012 which are qualitative researches and suitable for the meta analysis. This study is collected the 20 independent research studies for the further analyses. This study is based upon the previously research data and sample which is already taken by the previous studies, total investors out of which the responded investors were taken as a sample quoted by the different countries researches in their stock exchanges. In the studies, the investor’s rationality is measured after the evaluation of all the factors which are affecting the investors’ behaviour while they want to take decisions of buying and selling of securities into the IPO market. After that it would be easy to analyse that whether the investors are rational or not. This sample data are tested with the help of Neyeloff meta analyses and forest plots as a tool.

Calculation of Q (chi-square)

The Q symbol is developed for a chi-square statistic in which k denoted as the total number of studies and degree of freedom comes when k interpreted with minus 1. This study null hypothesis is that the studies are rational. To verify the hypothesis, it needs to calculate the chi-square and compare the chi-square value against the chi-square table values. The calculated value of the chi-square is less than the table’s value then the study accepts the null hypothesis, otherwise rejects the same.

Values through using fixed effect model

The formula of Q ( w * es 2 ) w * es 2 w

Q = 2707.22 and rejects the null hypothesis.

Calculation of I²

This I² is considered as a method to measure the heterogeneity between the independent studies in the meta analysis.

The formula of I² = (Q-df) Q*100

I² = 99.2982

In the case of low heterogeneity, the fixed effect model can be used, but in this study the value of I² is more than 26 per cent so the data is containing high heterogeneity. Now it is time to proceed with the random effect model and after applying this model. The value of Q is come lower from the table’s value 10.117 at 5 per cent significant level and at degrees of freedom 19 found in a chi-square distribution and the value of I² is also very low.

Results and Discussions with Meta Analyses

This article has focused on the contours of the investors’ rationality and their behavioural aspects which are studied earlier while taking the IPO investment decisions. The IPO investors rationality studies are calculated by using the meta analyses and analysed that the investors are rational or not. In this study level of significance is fixed at 5 per cent and the decisions are correct to the extent of 95 per cent significance level. In this study, fixed effect model gives the results of very high variability in the studies and rejected the hypothesis of investors’ rationality. But with the use of random effect model, the studies are correlated to each other and found homogeneous data which is accepted as the hypothesis. By use of the data of previous 20 studies on the investors’ rationality figures out that the Q value 3.2712 that is less against the table’s value 10.117 at 5 per cent significant level, at the 19 degrees of freedom found in a chi-square distribution. As the Q value is less than the table value of chi-square thus the null hypothesis is accepted. The random effect model concludes that the study is homogeneous and the investors are found to be rational. There is no significant impact of the psychological factors on the investor’s decision making. Most of the investors’ decisions are found rational and treat the wait and watch policy and present available information in their investment decisions. The investors are very conscious and their decisions are influenced by the various behavioural finance aspects. There are a large number of researches on the behavioural finance covering the contours of investor’s overconfidence, disposition effect, conservatism, mental accounting, cognitive dissonance, herding and regret theory.

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Figure 2.

Source: Neyeloff et al. (2012).

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Figure 3.

Source: Neyeloff et al. (2012).