Dynamic Style Preferences of Individual Investors and Stock Returns

Abstract

This study examines whether changing style preferences of individual investors influence returns. Using data from a large U.S. discount brokerage house, first, I show that investors exhibit time-varying style preferences. These preference shifts are influenced by past style returns and earnings differentials, and expert advice from investment newsletters, but are unaffected by innovations in macro-economic variables or shifts in investors' expectations about stocks' future cash-flows. Next, I show that investors' changing style preferences influence style returns. The contemporaneous relation between style returns and style level preference shifts is strong and there is also weak evidence of style return predictability. Moreover, within-style mean return correlation is positively related to the magnitude of investors' preference shifts.