Essays in Behavioral Finance

In the first chapter, we show that individuals' non-investment risk-taking behavior can affect their willingness to take financial risks. To test this hypothesis, we use the initial legalization and opening of commercial casinos in the U.S. as a natural experiment and show that the opening of a casino in close geographical proximity to investors results in increased portfolio risk taking of those investors who are likely to gamble relative to those investors who are not. These likely gamblers, who are exposed to increased risk taking, subsequently realize higher returns, but do not improve the overall mean-variance efficiency of their portfolios. These findings provide insight into the nature of risk taking and the amplifying effect that taking risks in one context may have on investment risk taking. In the second chapter, we explore how social preferences may guide individuals' investment decisions in the context of "sin stocks." We find that investors who disregard social norms and invest increasingly greater proportions of their portfolios in sin stocks tend to realize lower risk-adjusted returns net of transaction costs than investors who do not invest in sin stocks. Using additional unique survey data, we find that sin stock investors tend to be more overconfident and trade more often. Finding are consistent with the notion that investors who disregard social norms and invest in sin stocks are more likely to be subject to overconfidence, as well as more likely to drink, smoke, or gamble, which are associated with behavior that affects investment decisions and portfolio outcomes. In the final chapter, we find a CEO's overconfidence can also indirectly affect other market participants, specifically analysts who issue earnings forecasts. We find that firms with overconfident CEOs are more likely to have analysts issue earnings forecasts that are more optimistic relative to actual earnings. Furthermore, we find that firms with overconfident CEOs have analyst forecasts with smaller absolute forecast errors and are less dispersed. These findings demonstrate the importance of CEOs' behavioral characteristics in shaping the environment in which analysts and other market participants make important financial decisions, in some cases improving the information environment.Ph.D