Those Who Learn from History Are Doomed to Repeat It

Abstract

We see the stock market constantly responding to changing signals. These inputs are perceived to be highly structured in both space and time. Such regularities in the environment allow expectations about the future to be formed, facilitating current investment decisions. Perceiving the continuous stability is exploited by the brain, creating a bias in perception to generate serial dependence. Therefore, stock price dependence may be simply a result of the behavioral dependence in the decision process. The empirical evidence presented in this paper confirms that the dependence in every facet of an investment decision process has contributed to the observed stock price dependence. The largest contributor is by far from investors’ memory dependence, exceeding 80%. If history is the record of past decisions going through the brain’s neural pathways, the memory dependence or “memory of the memory” occurs when people follow the same old neural pathway over time. As paying attention to history is an obvious mental visit to the memory neural pathways, those who study the history are doomed to repeat it.

Keywords:

• Cross dependence
• memory
• perception
• decision
• perception
• stimulus
• history
• stock price cycle
• behavioral finance

JEL CLASSIFICATIONS:

• C5
• C9
• G4

Notes

1 In the case of IPOs, as Brau and Fawcett (2006) note, IPOs’ post-offering returns may relate more to sentiment and cosmetic accounting/reporting just prior to issuance.

2 Using the example above to illustrate our point, the model obviously does not suggest that a DKNG investor would remember a seemingly random stock GWPH’s price movements in 7 years ago.  But both investors will "behave" the same way because of the common behavioral dependence more from perception and memory, less from the signal.  

3 Variations on the repeating-history theme appear alongside debates about attribution. Irish statesman Edmund Burke is often misquoted as having said, “Those who don’t know history are destined to repeat it.” Spanish philosopher George Santayana is credited with the aphorism, “Those who cannot remember the past are condemned to repeat it,” while British statesman Winston Churchill wrote, “Those that fail to learn from history are doomed to repeat it.”

4 If the world is generally stable, objects are more likely to repeat than change. Given the stability of the perceived world, such a prior could make perception more robust by filtering out temporal noise. These findings elucidate how our perceptual decisions are dependent to our short-term perceptual history.

5 Since the publication of Fama’s Efficient Market Hypothesis in 1970, how to conduct an event study became a required methodology for finance academicians.

6 See Cicchini, Anobile, and Burr (2014), Fischer and Whitney (2014), Liberman, Fischer, and Whitney (2014), anRahnev et al. (2015).

7 Memory formation largely occurs in the brain's limbic system, which regulates learning, memory, and emotions.

8 Finally, the hippocampus sends the long-term memories to different areas of the cortex, depending on the type of memory. The memories are then stored in the synapses where they can be reactivated later.

9 This is from a comment of the reviewer.

10 “Cross” correlation means the correlation between one stock’s returns in one time period and another stock’s returns in a different time period.

11 This question was asked by the referee.

12 We are not saying Ford investors will actually "use or remember" Hanger Orthopedics’ historical prices to trade, but both investors will "behave" the same way because of the common behavioral dependence (more from perception and memory, not from signals).  

13 Last two questions were raised by the Editor.

14 For example, even after we applied many liquidity screens on the investable universe, a 6-month back test often took 24 hours to run on our PCs.

15 This time unspecificity may be similar to the location unspecificity in a previous study (Fischer and Whitney 2014), in which serial dependence transferred across time and space.

16 Computing power is a serious constraint of our methodology.