Reinforcement learning and risk preference in equity linked notes markets

Reo Song, Sungha Jang, Yingdi Wang, Dominique M. Hanssens and Jaebeom Suh

Journal of Empirical Finance, 2021, vol. 64, issue C, 224-246

Abstract: Individuals who follow a reinforcement learning heuristic put too much weight on recent failures or successes in placing their next bets. Using a large sample of equity-linked notes (ELNs) investments in South Korea, we find evidence showing a negative effect of reinforcement learning on future investments that lasts longer than one investment period. After losses, investors are less likely to repurchase equity-linked notes and spend less on their repurchases. This behavior also results in reinforcement learners underperforming rational agents. The difference in returns received by reinforcement and non-reinforcement groups is economically large at approximately 10.7%. However, these negative effects of reinforcement learning are mitigated by investors’ higher risk attitudes. We find that more risk-seeking investors are less likely to shun ELNs after undesirable prior returns and that this effect persists for more than one period. The underperformance of reinforcement learners is also reduced with high risk-taking. Overall, our findings highlight how combining different psychological traits can diagnose and improve biases in investor decision-making.

Keywords: Reinforcement learning; Risk preference; Equity-linked notes; Financial decisions (search for similar items in EconPapers)
JEL-codes: G11 G40 G41 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0927539821000785
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:64:y:2021:i:c:p:224-246

DOI: 10.1016/j.jempfin.2021.09.004

Access Statistics for this article

Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

More articles in Journal of Empirical Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().