Irrational Investing in a Risky Nigerian Equity Market

International Journal of Economics and Management Studies

© 2020 by SSRG - IJEMS Journal

Volume 7 Issue 1

Year of Publication : 2020

Authors : Omokehinde , Joshua Odutola , Olurin, Enitan Rotimi

10.14445/23939125/IJEMS-V7I1P108

How to Cite?

Omokehinde , Joshua Odutola , Olurin, Enitan Rotimi, "Irrational Investing in a Risky Nigerian Equity Market," SSRG International Journal of Economics and Management Studies, vol. 7,  no. 1, pp. 53-65, 2020. Crossref, https://doi.org/10.14445/23939125/IJEMS-V7I1P108

Abstract:

The paper investigates the irrational behavior of investors in therisky Nigerian equity market from January 4, 2014, to September3, 2019, using: descriptive and diagnostic statistics to test the marketbehavior; Jensen ALPHA, CAPM, Sortino, Shapre,  Treynor,and Fama'sreturn decomposition as standard tools to evaluate the irrational investing behavior of investors in the Nigerian equity market. The minimum acceptable return or risk-free rate stood at 12.76% during the period. The target market and portfolio returns were miscalebrated, which resulted in negative outcomes. The findings revealed that the excess of market and portfolio returns over risk-free were generally negative. The equity investment was risky as market and portfolio risks were grossly higher than their returns. The market return was volatile and did not behave normally as its kurtosis and skewness varied from the normal zero and 3.0 standards. The decomposition of the market and portfolio returns revealed that the systematic and unsystematic risks negatively influenced the risk-free to the extent that their total returns suffered losses that the selection opportunities could not remedy. The Treynor, Sharpe, and Jensen ratios were negative for the market and the portfolios. Jensen's Alpha is negative for both the market and the portfolios, which indicated that the risk-adjusted performance of the portfolios was not attractive. The CAPM indicates that the risk premium was negative for all the portfolios as the market return is lower than the risk-free rate. The Sortino ratio was also negative, and the average downside risk to total risk stood at 84.22%, indicating high downside volatility, meaning that for every N1.0 investment in the equity market, the probability of loss was lost 84.22kobo and 15.78kobo gain. It also attests that risk-averse investors were better than risk-seeking investors in the Nigerian equity market. The paper concluded that investors in the Nigerian equity marketbehaved irrationally and recommended that they avoid taking additional risksunless the risk premium is adequately compensatory for the degree of risk-taking.

Keywords:

Irrational investing, risk premium, minimum acceptable Return, Systematic Risk, Unsystematic risk, Downside risk.

References:

[1] Black, F., Noise. Journal of Finance, 41(3) (1986) 529–543.
[2] Barberis, N.C., Shleifer, A., Vishny, R., A model of investsor sentiment. Journal of Financial Economics, 49(3) (1998)307–343.
[3] Daniel, K., Hirshleifer, D., Teoh, S.H., Investor psychology in capital markets, Evidence and policy implications. Journal of Monetary Economics, 49(1) (2002) 139–209.
[4] Elumah, L., Ilo, B., and Yinusa, O. Performance of Mutual Funds in Nigeria. The EIB International Journal of Finance, 17 (2018) 8-25
[5] Fama, E. F., & French, K. R., The Cross-Section of Expected Stock Returns. The Journal of Finance, 47 (2) (1992) 427-465
[6] Fama, E. F., & French, K. R., Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33 (1993) 3-56.
[7] Fama, E. F., & French, K. R., Size, value, and momentum in international stock returns. Journal of Financial Economics. 105 (3) (2012) 457-472.
[8] Fama, E. F., & French, K. R., A Five-Factor Asset Pricing Model. Journal of Financial Economics. 116 (2015) 1–22.
[9] Fama, E. F., & French, K.R., Size and book-to-market factors in earnings and returns. The Journal of Finance, 50 (1) (1995) 131-155.
[10] Fama, E. F., & MacBeth, D. F., Risk, Return, and Equilibrium, Empirical Tests. Journal of Political Economy, 81(3) (1973) 607-636.
[11] Fama, E.F., Random Walks in Stock Market Prices. Financial Analyst Journal, 21(5) (1965) 55-59. 
[12] Fama, E.F., Efficient Capital Markets, A Review of Theory and Empirical Work, Journal of Finance, 25(1970) 383-417.
[13] Gauss, C. F., Theoria Combinationis Observationum Erroribus Minimis Obnoxiae, Parts 1, 2, and Supplement, Werke, 4 (1821) 1-108.
[14] Jensen, M. C., Black, F., & Scholes, M. S. (1972). The Capital Asset Pricing Model, Some Empirical Tests. Retrieved from http,//papers.ssrn.com/abstract=908569.
[15] Kahneman, D. and Tversky, A., Prospect theory, an analysis of decision under risk. Econometrica 47 (1979) 263–91.
[16] Kahneman, D., & Tversky, A., Subjective probability, A judgment of representativeness. Cognitive Psychology, 3 (1972) 430–454. 
[17] Kahneman, D., & Tversky, A., Prospect theory, An analysis of decision under risk. Econometrica, 47 (1979) 263–291. 
[18] Kundu Abhijit., Stock Selection Performance of Mutual Fund Managers in India, An Empirical Study, Journal of Business and Economic Issues, 1(1) (2009)59-72.
[19] Le Mens, G., & Denrell, J., Rational learning and information sampling, On the 'naivety' assumption in sampling explanations of judgment biases. Psychological Review, 118 (2) (2011) 379–392. 
[20] Li, Y., Yang, L., Prospect theory, the disposition effect, and asset prices. Journal of Financial Economics, 107(3) (2013) 715–739.
[21] Lintner, J., The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets.  Review of Economics and Statistics. 47 (1) (1965) 13–37.
[22] Lo, A., Long-term Memory in Stock Market Prices. Econometrica 59 (1991)1279–313.
[23] Lo, A.,Market Efficiency, Stock Market Behavior in Theory and Practice, 2 vols.Cheltenham, Edward Elgar Publishing Company(1997).
[24] Lo, A. W., The adaptive market hypothesis. Journal of Portfolio Management, 30(5) (2004)15–29.
[25] Lo, A. W., Reconciling efficient market hypothesis with behavioral finance, The adaptive market hypothesis. Journal of Investment. 7(2) (2005) 21–44.
[26] Loewenstein, M., Willard, G.A., The limits of investor behavior. Journal of Finance, 61(1) (2006) 231–258.
[27] Jones, B.D., Bounded rationality. Annual Review of Political Science, 2(1) (1999) 297–321.
[28] Fama, E.F., Market efficiency, long-term returns, and behavioral finance. Journal of Financial Economics, 49(3) (1998) 283–306.
[29] De Bondt, W.F., Investor psychology and the dynamics of security prices. AIMR Conference Proceedings, 1995(7)(1995) 7–13.
[30] Lopes, L. L., & Oden, G. C. (1991). The rationality of intelligence. In E. Eells &  T. Maruszewski (Eds.), Rationality and reasoning, Essays in honor of L. J. Cohen (pp. 199–223). Amsterdam, Rodopi.
[31] Madiha, L., Shanza, A., Marian, F., & Samia, F., Market efficiency, market anomalies, causes, evidence, and behavioral aspects. Research Journal of Finance and Accounting, 2(9) (2011) 1-13.
[32] Markowitz, H. M., Portfolio selection. Journal of Finance, 7(1) (1952) 77-91.
[33] Markowitz, H. M., Portfolio Selection, Efficient Diversification of Investments. Cowles Foundation Monograph N0.16, New York, John Wiley & Sons, Inc(1959).
[34] MSCI, BARRA., Long-Short BARRA Factor Indexes(2013). Retrieved from http,//www.msci.com/.../MSCI_Barra_Factor_%20indices_Methodology_NOV,13 pdf.
[35] Mussweiler, T., Comparison processes in social judgment, Mechanisms and consequences. Psychological Review, 110 (2003) 472–489. 
[36] Nwidobie, B. M., Agency Conflict and Corporate Dividend Policy Decisions in Nigeria. Asian Economic and Financial Review, 3(8) (2013) 1096-1109.
[37] Oke, B. O., Capital Asset Pricing Model (CAPM), Evidence from Nigeria. Research Journal of Finance and Accounting, 4(9) (2013) 17-26. 
[38] Olakojo, S.A., & Ajide, K. B., Testing the Capital Asset Pricing Model (CAPM), The Case of the Nigerian Securities Market. International Business Management, 4(2010) 239-242.
[39] Ritov, I., Anchoring in simulated competitive market negotiation. Organizational Behavior and Human Decision Processes, 67 (1) (1996) 16–25. 
[40] Ross, S. A.,  The arbitrage theory of capital asset pricing.   Journal of Economic Theory, 13(3) (1976) 341–360.
[41] Sayim, M., Rahman, H., The relationship between individual investor sentiment, stock return, and volatility, Evidence from the Turkish market. International Journal of Emerging Markets, 10(3) (2015) 504–520.
[42] Schlinger, J.H.D., Theory of mind, An overview and behavioral perspective. Psychological Record, 59(3), 435–448.
[43] Sharpe, W. F.,.  Capital Asset Prices, A Theory of Market Equilibrium under Conditions of Risk.  Journal of Finance, 19  (1964)(2009) 425-442.
[44] Sharpe, W. F., & Cooper, G. M., Risk-Return Classes of New York Stock Exchange Common Stocks, 1931-1967.  Financial Analysts Journal, 28(2) (1972) 46-81.
[45] Shiller, R. J., The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure. The Journal of Political Economy, 87(6) (1979) 1190 1219.
[46] Shiller, R.J., Market Volatility. MIT Press, Turan G. Bali, Stephen J. Brown, Scott Murray, Yi Tang (2017) A Lottery-Demand-Based Explanation of the Beta Anomaly, Journal of Financial and Quantitative Analysis, 52(6) (1989) 2369-
[47] Shleifer, A., Summers, L.H., The noise trader approach to finance. Journal of Economic Perspectives, 4(2) (1990) 19–33.
[48] Summers, B., Duxbury, D., Decision-dependent emotions and behavioral anomalies. Organizational Behaviour and Human Decision Processes, 118(2) (2012) 226–238.
[49] Statman, M., Behavioral finance, Finance with normal people. Borsa Istanbul Review, 14(2) (2014)65–73.
[50] Thaler, R.H., Advances in Behavioral Finance. New York, Russell Sage Foundation(1993).
[51] Thaler, W., Does The Stock Market Overreact? Journal Of Finance 40 (1984) 793-805.
[52] Tobin, J., Liquidity Preference as Behaviour Towards Risk. The Review of Economic Studies, 25(2)(1958) 65-86.
[53] Treynor to the fall of. A final version was published in 1999 in Asset Pricing and Portfolio Performance. Robert A. Korajczyk (editor) London, Risk Books, (1962)15-22.
[54] Tversky, A., Kahneman, D.,  Advances in prospect theory, Cumulative representation of uncertainty. Journal of Risk and Uncertainty. 5 (4)(1992) 297–323.
[55] Tversky, A., Kahneman, D., The framing of decisions and the psychology of choice. Science, 211(4481) (1981) 453–458.
[56] Tversky, A., Kahneman, D., Judgment under uncertainty, Heuristics and biases. Science, 185(4157) (1974) 1124–1131.
[57] Tversky, Amos; Kahneman, Daniel., Rational Choice and the Framing of Decisions. The Journal of Business. 59 (4)(1986) 251–278.