How the Shift to Quality Distinguished Winners from Losers During the Financial Crisis

We examine winner and loser portfolios as a result of the financial crisis from 2007 to 2008 to determine the ex-ante characteristics of winner and loser stocks. The best performing decile actually gained more than 27% in our sample of 2,267 firms while the worst performing decile lost nearly 90% of its value. We show that investor sentiment shifted away from risky stocks, but risk aversion went beyond an avoidance of market and intrinsic risk. Smaller, value stocks with high-leverage significantly underperformed the market while investors shifted to larger, glamour stocks with high dividend yields. Our results provide strong support for the theories of projection bias, risk aversion and regret avoidance.