We use novel data on individual activity in a sports betting market to study the effect of past performance sequences on individual behavior in a real market. The revelation of fundamental values in this market enables us to disentangle whether behavior is caused by sentiment or by superior information about market mispricings, hence to cleanly test in a real setting two sentiment-based theories of momentum and reversals — the regime-shifting model of Barberis, Shleifer, and Vishny (1998) and the gambler’s/hot-hand fallacy model of Rabin (2002). Furthermore, our long panel allows us to calculate the proportions of individuals who exhibit each type of behavior. We find that i) three quarters of individuals exhibit trend-chasing behavior; ii) seven times as many individuals exhibit behavior consistent with Barberis, Shleifer, and Vishny (1998) as exhibit behavior consistent with Rabin ( 2002); and iii) no individuals earn superior returns from momentum trading.

Barras, Scaillet, Wermers (2010) propose the False Discovery Rate to separate skill (alpha) from luck in fund performance. Using simulations with parameters informed by the data, we find that this methodology is overly conservative and underestimates the proportion of nonzero-alpha funds. E.g., 65% of funds with economically large alphas of ±2% are misclassified as zero-alpha. This bias arises from the low signal-to-noise ratio in fund returns and the consequent low statistical power. Our results raise concerns regarding the FDR’s applicability in performance evaluation and other domains with low power, and can materially change its conclusion that most funds have zero alpha.

Online Appendix

Using trading data from a sports-wagering market, we estimate individual dynamic risk preferences within the prospect-theory paradigm. This market’s experimental-like features greatly facilitate preference estimation, while our long panel enables us to study whether preferences vary across individuals and depend on earlier outcomes. Our estimates extend support for existing experimental findings — mild utility curvature, moderate loss aversion, probability overweighting of extreme outcomes — to a real financial market, but also reveal that risk attitude is heterogeneous and history-dependent. Applying our estimates to a portfolio-choice problem, we show prospect theory can better explain the prevalence of the disposition effect than previously thought.

Online Appendix

We construct novel measures of funds’ environmental, social, and governance (ESG) commitment by applying text analysis to the discretionary investment-strategy descriptions in their prospectuses. We find that investors respond strongly to text-based ESG measures. Using discrepancies between text- and fundamentals-based ESG measures, we identify greenwashing funds. We find greenwashing is more prevalent in the last five years and among funds with lower past flows and weaker oversight. Furthermore, greenwashing funds attract similar flows as funds that truthfully reveal their ESG commitment, suggesting that investors cannot distinguish between them. On the other hand, greenwashers have inferior performance than genuinely green funds.

Online Appendix

We propose a novel methodology that jointly estimates the proportions of skilled/unskilled funds and the cross-sectional distribution of skill in the mutual fund industry. We model this distribution as a three-component mixture of a point mass at zero and two components — one negative, one positive — that we estimate semi-parametrically. This generalizes previous approaches and enables information-sharing across funds in a data-driven manner. We find that the skill distribution is non-normal (asymmetric and fat-tailed). Furthermore, while the majority of funds have negative alpha, a substantial 13% generate positive alpha. Our approach improves out-of-sample portfolio performance and significantly alters asset allocation decisions.

Online Appendix

We use the sports betting market as a real-market laboratory to test a key but hitherto-untested assumption underlying the behavioral explanation of home bias in finance: that a behavioral home bias is strong enough to persist in market settings and survive costly implications. We find that individuals exhibit a bias toward home-team wagers, which does not yield superior performance but distorts their portfolios, generating welfare costs of similar magnitude as in the stock market. Our finding injects new evidence to the debate on the drivers of the home bias in financial markets and solidifies the foundation of the behavioral explanation.

Online Appendix

While it is commonly accepted that risk preferences differ across individuals, studies that estimate them typically allow for limited heterogeneity. We develop a methodology that allows for richer representation of heterogeneity both within and across utility types characterized by different behavioral features. This enables us to improve individual- and population-level estimates, and to assess the relative importance of loss aversion and probability weighting, and their prevalence in the population. Applying our model to individual sports-betting choices, we find that utility curvature alone does not explain observed choices and, while two-thirds of individuals exhibit loss aversion, all exhibit probability weighting.

Online Appendix

We investigate whether managers’ intrinsic incentives affect firms’ environmental policies. Exploiting within-facility variation in facility-to-CEO-birthplace distances, we find that facilities located near CEOs’ birthplaces experience toxic emission reductions relative to those farther away. This is achieved by reducing waste generation at source rather than by downsizing operations or substituting pollution across locations. The effect is strongest for hometown facilities in high-polluting areas, and in firms with higher cash holdings and with CEOs with weaker pay incentives. Our results suggest that local representation in management or on boards could be a powerful means of encouraging corporate pollution abatement.