Swedroe: Hedge Fund Managers Reflect Their Cars

February 22, 2017

Sensation-seeking is a personality trait that can be described as the seeking of varied, novel, complex and intense sensations and experiences, and the willingness to take physical, social, legal and financial risks for the sake of such experiences. Does sensation-seeking affect the behavior of financial market participants, such as professional fund managers?

That’s exactly the question that Stephen Brown, Yan Lu, Sugata Ray and Melvyn Teo, the authors of the December 2016 paper “Sensation Seeking, Sports Cars, and Hedge Funds,” attempt to answer.

The field of behavioral finance has provided us with some important insights on the subject. For example, the research has found that individuals prefer stocks with low nominal prices, high volatility (and high beta) and high positive skewness (in which returns to the right of, or more than, the mean are fewer, but further from it, then returns to the left of, or less than, the mean, like a lottery ticket). In other words, they have a preference for gambling. Research has also found that investors with gambling preferences trade actively.

What A 'Sensational' Car Suggests

Brown, Lu, Ray and Teo contribute to the literature by examining professional hedge fund investors. Their study used data on hedge fund managers’ automobile ownership to gauge their proclivity for sensation-seeking and then analyzed the impact on behavior and performance. The authors examined the characteristics of vehicles the managers purchased, such as body style, maximum horsepower, maximum torque, passenger volume and safety ratings.

Their working hypothesis was that “the purchase of a powerful sports car, more often than not, conveys the intent to drive in a spirited fashion and therefore signals an inclination for sensation seeking. Conversely … the acquisition of a practical but unexciting minivan reflects an aversion to sensation seeking.”

The study covered the period 994 through 2012 and nearly 50,000 hedge funds. To quote the authors, “the empirical results are striking.” Specifically:

 

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