Adaptive Benchmarks Based on Stock and Market Performances in Repurchase Decisions

Recently, reinforcement has been identified as an important driver of stock repurchasing decisions. We enrich the existing reinforcement model of repurchasing by an aspiration-based market benchmark. Reinforcement relative to an adaptive benchmark is a well-established model of behavior in psychology, but not yet investigated in finance. When choosing which stock to repurchase, investors' sources of reinforcement are weighted averages of absolute returns and returns relative to the market from previous sales. The weights change according to market environments. We empirically identify the following crucial asymmetry that cannot be reconciled by simple reinforcement strategies, but is consistent with the model we propose: investors place more weight on market-relative returns when the market is performing well, and more weight on absolute returns when the market is performing badly. Psychologically, this is also consistent with the 'ostrich effect'. We conclude with a discussion of the implications for individual investors and private wealth managers.