Do psychological fallacies influence trading in financial markets? Evidence from the foreign exchange market

Bleaney, Michael; Bougheas, Spiros; Zhiyong, Li

Abstract

Research in both economics and psychology suggests that, when agents predict the next value of a random series, they frequently exhibit two types of biases, which are called the gambler’s fallacy (GF) and the hot hand fallacy (HHF). The gambler’s fallacy is to expect a negative correlation in a process which is in fact random. The hot hands fallacy is more or less the opposite of this – to believe that another heads is more likely after a run of heads. The evidence for these fallacies comes largely from situations where they are not punished (lotteries, casinos and laboratory experiments with random returns). In many real-world situations, such as in financial markets, succumbing to fallacies is costly, which gives an incentive to overcome them. The present study is based on high-frequency data from a market-maker in the foreign exchange market. Trading behaviour is only partly explained by the rational exploitation of past patterns in the data. There is also evidence of the gambler’s fallacy: a tendency to sell the dollar after it has risen persistently or strongly.

Citation

Bleaney, M., Bougheas, S., & Zhiyong, L. (2017). Do psychological fallacies influence trading in financial markets? Evidence from the foreign exchange market. Journal of Behavioral Finance, 18(3), 344-357. https://doi.org/10.1080/15427560.2017.1331234

• Journal Article Type: Article
• Acceptance Date: Feb 11, 2016
• Online Publication Date: Jun 13, 2017
• Publication Date: 2017
• Deposit Date: Feb 17, 2016
• Publicly Available Date: Jun 13, 2017
• Journal: Journal of Behavioral Finance
• Print ISSN: 1542-7560
• Electronic ISSN: 1542-7579
• Publisher: Routledge
• Peer Reviewed: Peer Reviewed
• Volume: 18
• Issue: 3
• Pages: 344-357
• DOI: https://doi.org/10.1080/15427560.2017.1331234
• Keywords: gambler's fallacy, hot hand fallacy, foreign exchange market
• Public URL: https://nottingham-repository.worktribe.com/output/971176
• Publisher URL: https://www.tandfonline.com/doi/full/10.1080/15427560.2017.1331234