Post on 22-Jan-2016
description
Behavioral Finance –
A Challenge to Market Efficiency
Henry Fiebelkorn
Behavioral Economics
Dr. D. Kuebler, SS2003
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 2
Structure
Introduction Behavioral Finance and Overview
Summary and Outlook
Market Phenomena - Anomalies
I
V
II
Financial Asset Pricing Theory – Behavioral ModelsIII
Applying Behavioral FinanceIV
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 3
Introduction
„Modern finance theorists have turned finance into a science,
but they forgot that it is a social science!“
State of Modern Finance:
Current State:
Behavioral Finance:
PerfectPerfect Markets & PerfectPerfect People
ImperfectImperfect Markets & PerfectPerfect People
ImperfectImperfect Markets & Imperfectmperfect People
BF:is the application of psychology to financial behavior –
the behavior of practioners.
Aim: recognize, understand and avoid mistakes.
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 4
Behavioral Finance
Classification
Framing Aspects
Heuristics Self-Concept
Mental Accounting
Prospect Theory
Representativeness
Availability
Anchoring
Ambiguity Aversion
Overconfidence
Self-Attribution
Cognitive Dissonanz
Self-Control
Confirmation Bias
Herding
Conservatism
Underlying Concepts:
1. Bounded Rationality2. Emotions
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 5
Structure
Market Phenomena - Anomalies
Summary and Outlook
II
V
Financial Asset Pricing Theory – Behavioral ModelsIII
Applying Behavioral FinanceIV
Introduction Behavioral Finance and OverviewI
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 6
Anomalies
Volume
Volatility
Dividends
Equity Premium Puzzle
Book-to-Market Ratio
1. Anomalies are consistent
2. Violate the Efficient Market Hypothesis
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 7
Structure
Introduction Behavioral Finance and Overview
Summary and Outlook
Market Phenomena - Anomalies
I
V
II
Financial Asset Pricing Theory – Behavioral ModelsIII
Applying Behavioral FinanceIV
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 8
Model of Investor Sentiment
Existing Approaches
“Inefficient Markets” by Shleifer (2000)
Abitrageurs:
• Follow Standard CAPM: No cognitive errors
• Utility expressed motives• Try to exploit Noise Trader
Information Trader Noise Trader
Outside CAPM (BAPM):
• Cognitive errors: listen to gurus, follow rumors
• Value expressed motives
= Investor Sentiment
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 9
Model of Investor Sentiment
Existing Approaches
Abitrage is limited because:
1. Securities don´t have obvious substitutes
2. Abitrage is risky (Risk Aversion)
3. Noise Trader Risk
Price changes in absence of fundamental news!
Belief about Noise Trader determines price
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 10
Model of Investor Sentiment
Existing Approaches
Price Determination: Two Earning Regimes:
• Prior views
• No revaluation due to
News News
Conservatism Representativeness
• give up old model
•Attach to new model due to
Underreaction Overreaction
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 11
BSV - Model
Existing Approaches
Captures 2 Judgement Biases:
Barberis, Shleifer, Vishny (1998)
Representative-ness Bias
Conservatism
Underreaction of Stock Prices
Overreaction of Stock Prices
Investors: 2 Earning Regimes:
Barberis, Shleifer, Vishny (1998)
Earnings are meanreverting
Firms´ earnings are trending
(+)
(-)Change
temporarely
Long-term-Change
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 12
DHS - Model
Existing Approaches
Captures 2 Judgement Biases:
Daniel, Hirshleifer, Subramanyam (1997)
Overconfidence Self-Attribution
Exaggerate Privat
Information
Downweight Public
Information
(+) (-)
Special Prediction: Selective Items
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 13
Behavioral Asset Pricing Model (BAPM)
Existing Approaches
16
Strong: JewelryLess: AutomobilesAbsent: Laundry
valu
e ex
pre
ssed
ch
arac
teri
stic
sEnable user to identify value of products
Risk: Automobiles: Laundry
Uti
litia
n
char
acte
rist
ics Rational Utility
Utilitarian characteristics vs. Value expressed characteristics (Timex /Rolex example)
“Behavioral Asset Pricing Theory” by Shefrin, Statmen (1994)
BA
PM
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 14
Model Requirements
Identification of preferences of the
buyers/sellers
Characteristics capturing value expressive (VEC) & utilitarian preferences (UC)
Conclude with equilibrium
prices
Behavioral Asset Pricing Model:
Should include:
1. What investors think2. How they asses risk3. How they forecast growth4. What rules they follow
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 15
Structure
Introduction Behavioral Finance and Overview
Summary and Outlook
Market Phenomena - Anomalies
I
V
II
Financial Asset Pricing Theory – Behavioral ModelsIII
Applying Behavioral FinanceIV
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 16
Applying Behavioral Finance
Investors
Limitations
Internal
• Mental Accounts• Heuristics• Self-Deception
External
• Biases information• Limitation of time
&resources• Practical restrictions
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 17
Applying Behavioral Finance
Emotional
Feelings
Investor
Performance Pressure
Time & Resource Constraints Uncertainty
Overload of
Information
Heuristics
Practical Restrictions
Biased
Information
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 18
Coping with Limited Rationality
Applying Behavioral Finance
4. Heuristics
1. Identify / Framing
2. Editing
3. Decomposition
„People are
intendedly rational but limited to do so!“
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 19
Applying Behavioral Finance
Behavior:
• Overreaction
• Underreaction
• Extrapolation
• Herd Behavior
Investment Strategies
• Value Investing
• Mean Reversion Strategy
• Momentum Strategy
• Event Studies
• Earning Revision Strategies
• Combination Studies
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 20
Loss Aversion
Behavioral Finance leads to product development
Applying Behavioral Finance
• Guaranteed products
• RenteMaXX
• Best of World Garant Fund
Overconfidence
Absolute Return
• Daytrading
• Hedge Funds:
• Event driven
• Opportunistic
• Relative value
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 21
Structure
Introduction Behavioral Finance and Overview
Summary and Outlook
Market Phenomena - Anomalies
I
V
II
Financial Asset Pricing Theory – Behavioral ModelsIII
Applying Behavioral FinanceIV
Seminar Behavioral Economics SS 2003 04-07-03 Behavioral Finance | 22
ll
1. Be aware of information biases:
seek and screen information actively
2. Avoid narrow framing, anchoring, overconfidence
3. Follow rules of decision making under uncertainty
Investor Market
1. Market and people are imperfect
2. There are systematic and recurring market inefficiencies
Anomalies are consistent and can´t be ignored
3. Sensible implementation of irrational human behavior into asset pricing models necessary
• VEC as well as UC must be included
Summary
What lessons does Behavioral Finance teach us?
Thanks for your attention!