Important academic paper to "calibrate" judgement related to corporate decision making:
Ben-David, Itzhak, Graham, John R. and Harvey, Campbell R., Managerial Miscalibration (August 8, 2012). Charles A. Dice Center Working Paper No. 2010-12; Fisher College of Business Working Paper No. 2010-03-012; AFA 2007 Chicago Meetings Paper . Available at SSRN: http://ssrn.com/abstract=1640552 or http://dx.doi.org/10.2139/ssrn.1640552
"We test whether top financial executives are miscalibrated using a unique 10-year panel that includes over 13,300 probability distributions of expected stock market returns. We find that executives are severely miscalibrated, producing distributions that are too narrow: realized market returns are within the executives’ 80% confidence intervals only 36% of the time. We show that the lower bound of the forecast confidence interval is lower during times of high market uncertainty; however, ex-post miscalibration is worst during these episodes. We also find that executives who are miscalibrated about the stock market show similar miscalibration regarding their own firms’ prospects. Finally, firms with miscalibrated executives appear to follow more aggressive corporate policies: investing more and using more debt financing."
Keywords: Overconfidence, Behavioral Biases, Behavioral Corporate Finance
Keywords: Behavioral Economics, Mental Accounting, Home Bias
"We test whether professional forecasters forecast rationally or behaviorally using a unique database, QSS Database, which is the monthly panel of forecasts on Japanese stock prices and bond yields. The estimation results show that (i) professional forecasts are behavioral, namely, significantly influenced by past forecasts, (ii) there exists a stock-bond dissonance: while forecasting behavior in the stock market seems to be herding, that in the bond market seems to be bold in the sense that their current forecasts tend to be negatively related to past forecasts, and (iii) the dissonance is due, at least partially, to the individual forecasters' behavior that is influenced by their own past forecasts rather than others. Even in the same country, forecasting behavior is quite different by market."
Keywords: Investing, Forecasts, Herding
Why "social animals" are often not the best investors:
Roy F. Baumeister, Todd F. Heatherton, Dianne M. Tice, When Ego Threats Lead to Self-Regulation Failure: Negative Consequences of High Self-Esteem, Journal of Personality and Social Psychology 1993, Vol. 64, No. 1,141-156
The tendency for people with high self-esteem to make inflated assessments and predictions about themselves carries the risk of making commitments that exceed capabilities, thus leading to failure. Ss chose their performance contingencies in a framework where larger rewards were linked to a greater risk of failure. In the absence of ego threat, Ss with high self-esteem showed superior self-regulation: They set appropriate goals and performed effectively. Ego threat, however, caused Ss with high self-esteem to set inappropriate, risky goals that were beyond their performance capabilities so they ended up with smaller rewards than Ss with low self-esteem. The results indicate the danger of letting egotistical illusions interfere with self-regulation processes.
Keywords: Investment, Psychology, Self-Esteem
David K. Levine, Salvatore Modica, Federico Weinschelbaum, Felipe Zurita, Evolving to the Impatience Trap: The Example of the Farmer-Sheriff Game, Working Paper 2012-033A, Federal Reserve Bank of St. Louis, 2012
"The literature on the evolution of impatience, focusing on one-person decision problems, finds that evolutionary forces favor the more patient individuals. This paper shows that in the context of a game, this is not necessarily the case. In particular, it offers a two- population example where evolutionary forces favor impatience in one group while favoring patience in the other. Moreover, not only evolution but also efficiency may prefer impatient individuals. In our example, it is efficient for one population to evolve impatience and for the other to develop patience. Yet, evolutionary forces move the wrong populations."
Keywords: Human Behavior, Patience, Impatience
"Our experiment reveals that envy and altruism strongly affect the utility of investment choices: about 70% of the subjects reveal envy, 10% reveal altruism, while 20% are indifferent. Envious subjects even prefer an inferior First degree Stochastic Dominance (FSD) investment choice, provided that their peer groups lose more. We develop bivariate utility-free Stochastic Dominance (SD) rules with envy and altruism. Surprisingly, some non-pathological altruism preferences (let alone envious preferences) induce a reduction in the univariate expected utility of all parties. However, with the additive preferences, we identify important cases where the bivariate and the univariate SD efficient sets coincide."
Keywords: Investment, Investment Choices, Altruism, Greed
Are we really as altruistic as we might like to think?
Keywords: Altruism, Self-Interest
Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”
In the cold world of the Street, the 'smart' crowd preys upon the 'dumb' money. But professionals are prone to greed, overconfidence and a blind faith that it's different this time. read more
Keywords: Investment, Greed, Overconfidence, Herding
a must read!
Keywords: Judgement, Reasoned Evaluation, "Illusion of Validity"
IF THE losses at UBS that surfaced this month were caused by a “rogue” trader, would that make his colleagues stable? Not if research being undertaken by John Coates, a neuroscientist at Cambridge University and a former derivatives trader, is anything to go by. read more in The Economist
Keywords: Traders, Hormones, Neuroscience
Keywords: Psychology, Behavioral Finance
THE extraordinary surge of stock market volatility during the last month can’t be explained by conventional means. Yes, hundreds of scholarly papers have tried to predict the size of such swings, and whole markets — like those for futures and options — thrive on these movements. Yet we still don’t have a clear, mathematical understanding of volatility’s source. read more in the NYT
Shiller refers in the article to Keynes who described the speculative process:
"John Maynard Keynes supplied the answer in 1936, in “The General Theory of Employment Interest and Money,” by comparing the stock market to a beauty contest. He described a newspaper contest in which 100 photographs of faces were displayed. Readers were asked to choose the six prettiest. The winner would be the reader whose list of six came closest to the most popular of the combined lists of all readers.
The best strategy, Keynes noted, isn’t to pick the faces that are your personal favorites. It is to select those that you think others will think prettiest. Better yet, he said, move to the “third degree” and pick the faces you think that others think that still others think are prettiest. Similarly in speculative markets, he said, you win not by picking the soundest investment, but by picking the investment that others, who are playing the same game, will soon bid up higher."
Source: Extract from article linked to above
Keywords: Speculative Process, Herding, Fear
I find following thoughts extremely valuable. Experiences during the financial crisis have "put risk capital on the sideline". It will be key that investors regain confidence.
Keywords: Risk Behavior, Risk Appetite
Professor Renata Salecl explores the paralysing anxiety and dissatisfaction surrounding limitless choice. Does the freedom to be the architects of our own lives actually hinder rather than help us? Does our preoccupation with choosing and consuming actually obstruct social change?
This is definitely a good basis for debate!
Keywords: Choice, Psychology, Decision Making, Ideology
Columbia Business School's Sheena Iyengar on The Power of Choice
Following book has been recommended in today's Finanz & Wirtschaft by Prof. Thorsten Hens, Institute for Banking and Finance of the University of Zurich:
"Inside the Investor's Brain provides investors with ways to examine their own financial psychology so they can better understand how to outsmart the crowd. Chapter by chapter, the author tackles different emotions and how they play a role in investing. Through examples, such as a gambling experiment with playing cards, the author shows readers how being aware of the subconscious can separate the smart investors from the average ones. The book also contains interviews with scientists, financial practitioners, and psychologists, all of whom offer an insider perspective. Lastly, the author includes brain images and graphics to link brain activity to investor behavior.
Unique insights into how the mind of an investor operates and how developing emotional awareness leads to long-term success
Inside the Investor's Brain provides readers with specific techniques for understanding their financial psychology, so that they can improve their own performance and learn how to outsmart other investors. Chapter by chapter, author Richard Peterson addresses various mental traps and how they play a role in investing. Through examples, such as a gambling experiment with playing cards, the author shows readers how being aware of the subconscious can separate the smart investors from the average ones. This book also contains descriptions of the work of neuroscientists, financial practitioners, and psychologists, offering an expert's view into the mind of the market. Innovative and accessible, Inside the Investor's Brain gives investors the tools they need to better understand how emotions and mental biases affect the way they manage money and react to market moves."
About the author:
Richard L. Peterson, MD, is a Managing Partner of Market Psychology Consulting, an Associate Editor at the Journal of Behavioral Finance, a psychiatrist, and a former trader. He has?written for a number of publications, including the Journal of Psychology and Financial Markets, and?was a contributor to the book Risk Management: A Modern Perspective. Peterson holds seminars around the world for investment professionals. He received his medical and bachelor's degrees from the University of Texas, completed his psychiatry training in the San Francisco Bay Area, and performed postgraduate neuroeconomics research at Stanford University.
Keywords: Behavioral Finance, Neuro Science
Following reasearch does say NO:
"The paper discusses the current state of the behavioral finance literature. I argue that more direct evidence on investors' actions and expectations would make existing theories more convincing to outsiders and would help sort among behavioral theories for a given asset pricing phenomenon. Furthermore, evidence on the dependence of a given bias on investor wealth/sophistication would be useful for determining if the bias could be due to (fixed) information or transactions costs or is likely to require a behavioral explanation, and for determining which biases are likely to be most important for asset prices.
Keywords: Behavioral Finance, Investor's Expectations, Investing in Market Peaks
Keywords: Human Behavior, Rationality, Self Interest, Altruism, Sociology, Agency Costs
Michael C. Jensen, Emeritus Professor, Harvard Business School, gave a conference on the topic: "Putting Integrity into Finance Theory and Practice : A Positive Approach".
Robert H. Frank explains that worrying constantly can contribute positively to human development:
"The human brain was formed by relentless competition in the natural world, so it should be no surprise that we adapt quickly to changes in circumstances. Much of life, after all, is graded on the curve. Someone who remained permanently elated about her first promotion, for example, might find it hard to muster the drive to compete for her next one."
read the NYT article here:
Keywords: Behavioral Economics, Happiness, Competition, Anxiety
Kuhnen, Camelia M., Samanez-Larkin, Gregory R. and Knutson, Brian, Serotonin and Risk Taking: How do Genes Change Financial Choices? (March 7, 2011). Available at SSRN: http://ssrn.com/abstract=1780552
"Financial decision making has a significant genetic component, but it is still unknown how genes influence choice. Focusing on the serotonin transporter gene, we find that individuals possessing the short version of the gene invest less in equities, are less engaged in actively making investments decisions, and have fewer credit lines. Short gene carriers do not differ from others with respect to cognitive skills, education, or wealth. However, psychological and brain imaging evidence shows they have higher levels of neuroticism and suggests that genetically-driven negative emotional reactions induce the short gene carriers to avoid risky and complex financial choices."
Keywords: Neuroeconomics, Neurofinance, Genetics, Serotonin, Financial Risk Taking, Emotions
D. Kahneman on his book "Thinking, Fast and Slow"
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