This podcast is a joint production with Wesley Gray of Alpha Architects. Wes invited Sam Hartzmark, assistant professor at the University of Chicago’s Booth School of Business, and Patrick O’Shaughnessy, of O’Shaughnessy Asset Management (OSAM).

Wes introduced Hartzmark as the most compelling researcher in academic finance land, with a specialty in asset pricing and behavioral finance. Hartzmark has an interesting perspective; he’s influenced by Eugene Fama and the classic efficient markets researchers at the University of Chicago.

Behavioral Finance

One of the most important biases Hartzmark studies is mental accounting. One of the earliest behavioral finance studies was around the disposition effect, or the tendency for investors to be much more likely to sell a position at a gain rather than at a loss. Hartzmark described the problem with this strategy as investors loading more highly on negative momentum strategies, leading to continually bad performance.

One paper Hartzmark wrote about this phenomenon shows that when investors have a loss, they roll their mental accounts from their first investment to the next. When investors are at a loss and close out the position at a loss, they are more likely to take on even riskier stock in their next investment in a desire to get even from their loss.

Dividends in the Behavioral Lens

Hartzmark also has looked at dividends from the behavioral finance lens, and he thinks dividends come into the mental accounting research as well. Hartzmark believes that many people exhibit what he calls a free dividend fallacy, or a view of dividends as being an independent source of return from the price of the stock, when in reality stock levels trade down by exact amounts of the dividend.

In some ways, this has investors looking at dividends from stocks in the same way as interest from bonds, and by his calculations, Hartzmark sees the demand for dividends correlating highly with low interest rate regimes.

O’Shaughnessy has looked at dividends extensively in his research as well. He wonders why firms pay dividends at all instead of looking at buybacks, and some of his research focuses on capital allocation, where firms that buy back stocks at cheap prices are some of the best opportunities.