Mark Twain’s Cat: Industry Investment Experience, Categorical Thinking and Stock Selection*

This paper studies the impact of prior investment experience in an industry on the subsequent purchase of new stocks in the same industry. Using trading records data for households at a large discount broker from 1991 to 1996, I establish that the experience of positive excess returns in a given industry increases the probability of purchasing similar stocks in that industry relative to other industries. This result is robust to industry momentum, wealth effects, and investor heterogeneity. The effect decays when the experience is further in the past. Furthermore, I find that investor sophistication mitigates this experience effect. These results are consistent with mechanisms where investors put more weight on their own experience than on other available historical information when updating the beliefs about an industrys future return. The results are also consistent with investors learning about their stock-picking ability in an industry from their experienced outcomes. *The cat, having sat upon a hot stove lid, will not sit upon a hot stove lid again. But he won’t sit upon a cold stove lid, either. –Mark Twain †Email: [email protected]. I am grateful for very helpful suggestions and comments of Stefano DellaVigna, David Laibson, Ulrike Malmendier, Gregor Matvos, Terrance Odean, Andrei Shleifer, Adam Szeidl, Nancy Wallace and seminar participants at UC Berkeley (Finance, Financial Economics Lunch) and London Business School Trans-Atlantic Doctoral Conference. I would also like to thank an anonymous discount broker for providing data on individual investors’ trades and Terrance Odean for his help in obtaining and understanding the dataset. All errors are my own.