Behavioral Finance E-Book

Edwin Burton

• Herausgeber: John Wiley & Sons
• Kategorie: Wissenschaft und neue Technologien
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 395

Veröffentlichungsjahr: 2013

Beschreibung

An in-depth look into the various aspects of behavioral finance Behavioral finance applies systematic analysis to ideas that have long floated around the world of trading and investing. Yet it is important to realize that we are still at a very early stage of research into this discipline and have much to learn. That is why Edwin Burton has written Behavioral Finance: Understanding the Social, Cognitive, and Economic Debates. Engaging and informative, this timely guide contains valuable insights into various issues surrounding behavioral finance. Topics addressed include noise trader theory and models, research into psychological behavior pioneered by Daniel Kahneman and Amos Tversky, and serial correlation patterns in stock price data. Along the way, Burton shares his own views on behavioral finance in order to shed some much-needed light on the subject. * Discusses the Efficient Market Hypothesis (EMH) and its history, and presents the background of the emergence of behavioral finance * Examines Shleifer's model of noise trading and explores other literature on the topic of noise trading * Covers issues associated with anomalies and details serial correlation from the perspective of experts such as DeBondt and Thaler * A companion Website contains supplementary material that allows you to learn in a hands-on fashion long after closing the book In order to achieve better investment results, we must first overcome our behavioral finance biases. This book will put you in a better position to do so.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Preface

Introduction

Part One: Introduction to Behavioral Finance

Chapter 1: What Is the Efficient Market Hypothesis?

INFORMATION AND THE EFFICIENT MARKET HYPOTHESIS

RANDOM WALK, THE MARTINGALE HYPOTHESIS, AND THE EMH

FALSE EVIDENCE AGAINST THE EMH

WHAT DOES IT MEAN TO DISAGREE WITH THE EMH?

Chapter 2: The EMH and the “Market Model”

RISK AND RETURN—THE SIMPLEST VIEW

THE CAPITAL ASSET PRICING MODEL (CAPM)

WHAT IS THE MARKET MODEL?

Chapter 3: The Forerunners to Behavioral Finance

THE FOLKLORE OF WALL STREET TRADERS

THE BIRTH OF VALUE INVESTING: GRAHAM AND DODD

FINANCIAL NEWS IN A WORLD OF UBIQUITOUS TELEVISION AND INTERNET

Part Two: Noise Traders

Chapter 4: Noise Traders and the Law of One Price

THE LAW OF ONE PRICE AND THE CASE OF FUNGIBILITY

NOISE

Chapter 5: The Shleifer Model of Noise Trading

THE KEY COMPONENTS OF THE SHLEIFER MODEL

RESULTS

WHY THE SHLEIFER MODEL IS IMPORTANT

RESOLVING THE LIMITS TO ARBITRAGE DISPUTE

Chapter 6: Noise Trading Feedback Models

THE HIRSHLEIFER MODEL

THE SUBRAHMANYAM-TITMAN MODEL

CONCLUSION

Chapter 7: Noise Traders as Technical Traders

TECHNICAL TRADERS AS NOISE TRADERS

HERD INSTINCT MODELS

CONCLUSION

Part Three: Anomalies

Chapter 8: The Rational Man

CONSUMER CHOICE WITH CERTAINTY

CONSUMER CHOICE WITH UNCERTAINTY

THE ALLAIS PARADOX

CONCLUSION

Chapter 9: Prospect Theory

THE REFERENCE POINT

THE S-CURVE

LOSS AVERSION

PROSPECT THEORY IN PRACTICE

DRAWBACKS OF PROSPECT THEORY

CONCLUSION

Chapter 10: Perception Biases

SALIENCY

FRAMING

ANCHORING

SUNK-COST BIAS

CONCLUSION

Chapter 11: Inertial Effects

ENDOWMENT EFFECT

STATUS QUO EFFECT

DISPOSITION EFFECT

CONCLUSION

Chapter 12: Causality and Statistics

REPRESENTATIVENESS

CONJUNCTION FALLACY

READING INTO RANDOMNESS

SMALL SAMPLE BIAS

PROBABILITY NEGLECT

CONCLUSION

Chapter 13: Illusions

ILLUSION OF TALENT

ILLUSION OF SKILL

ILLUSION OF SUPERIORITY

ILLUSION OF VALIDITY

CONCLUSION

Part Four: Serial Correlation

Chapter 14: Predictability of Stock Prices: Fama-French Leads the Way

TESTING THE CAPITAL ASSET PRICING MODEL

A PLUG FOR VALUE INVESTING

MEAN REVERSION—THE DE BONDT-THALER RESEARCH

WHY FAMA-FRENCH IS A MILESTONE FOR BEHAVIORAL FINANCE

Chapter 15: Fama-French and Mean Reversion: Which Is It?

THE MONTH OF JANUARY

IS THIS JUST ABOUT PRICE?

THE OVERREACTION THEME

LAKONISHOK, SHLEIFER, AND VISHNY ON VALUE VERSUS GROWTH

IS OVERREACTION NOTHING MORE THAN A “SMALL STOCK” EFFECT?

DANIEL AND TITMAN ON UNPRICED RISK IN FAMA AND FRENCH

SUMMING UP THE CONTRARIAN DEBATE

Chapter 16: Short-Term Momentum

PRICE AND EARNINGS MOMENTUM

EARNINGS MOMENTUM—BALL AND BROWN

MEASURING EARNINGS SURPRISES

WHY DOES IT MATTER WHETHER MOMENTUM IS PRICE OR EARNINGS BASED?

HEDGE FUNDS AND MOMENTUM STRATEGIES

PRICING AND EARNINGS MOMENTUM—ARE THEY REAL AND DO THEY MATTER?

Chapter 17: Calendar Effects

JANUARY EFFECTS

THE OTHER JANUARY EFFECT

THE WEEKEND EFFECT

PREHOLIDAY EFFECTS

SULLIVAN, TIMMERMANN, AND WHITE

CONCLUSION

Part Five: Other Topics

Chapter 18: The Equity Premium Puzzle

MEHRA AND PRESCOTT

WHAT ABOUT LOSS AVERSION?

COULD THIS BE SURVIVOR BIAS?

OTHER EXPLANATIONS

ARE EQUITIES ALWAYS THE BEST PORTFOLIO FOR THE LONG RUN?

IS THE EQUITY PREMIUM RESOLVED?

Chapter 19: Liquidity

A SECURITIES MARKET IS A BID-ASK MARKET

MEASURING LIQUIDITY

IS LIQUIDITY A PRICED RISK FOR COMMON STOCKS?

SIGNIFICANCE OF LIQUIDITY RESEARCH

Chapter 20: Neuroeconomics

CAPUCHIN MONKEYS

INNATENESS VERSUS CULTURE

DECISIONS ARE MADE BY THE BRAIN

DECISIONS VERSUS OUTCOMES

NEUROECONOMIC MODELING

MORE COMPLICATED MODELS OF BRAIN ACTIVITY

THE KAGAN CRITIQUE

CONCLUSION

Chapter 21: Experimental Economics

BUBBLE EXPERIMENTS

ENDOWMENT EFFECT AND STATUS QUO BIAS

CALENDAR EFFECTS

CONCLUSION

Conclusion: And the Winner Is?

THE SEMI-STRONG HYPOTHESIS—PRICES ACCURATELY SUMMARIZE ALL KNOWN PUBLIC INFORMATION

CAN PRICES CHANGE IF INFORMATION DOESN'T CHANGE?

IS THE LAW OF ONE PRICE VALID?

THREE RESEARCH AGENDAS

THE CRITICS HOLD THE HIGH GROUND

WHAT HAVE WE LEARNED?

WHERE DO WE GO FROM HERE? (WHAT HAVE WE NOT LEARNED?)

A FINAL THOUGHT

Index

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Copyright © 2013 by Edwin T. Burton and Sunit N. Shah. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Burton, Edwin T. Behavioral finance : understanding the social, cognitive, and economic debates / Edwin T. Burton and Sunit N. Shah. pages cm.—(Wiley finance series) Includes index. ISBN 978-1-118-30019-0 (cloth); ISBN 978-1-118-33410-2 (ebk); ISBN 978-1-118-33521-5 (ebk); ISBN 978-1-118-33192-7 (ebk) 1. Investments—Psychological aspects. 2. Capital market—Psychological aspects. 3. Decision making. I. Title. HG4521.B837 2013 332.01′9—dc23 2012041904

Preface

This book was the product of five years of teaching “Behavioral Finance” to over 1,800 undergraduates at the University of Virginia. The course never had a textbook. In fact, the course was originally intended to be limited to, at most, 15 students due to the difficulty of the reading. By a strange quirk of the registration process, the course limit in the online registration system was altered to 300 and was quickly filled by eager students. It remains one of the most sought after courses at the University of Virginia. Who would have guessed?

When I first decided to offer Behavioral Finance as a course, I was driven by the amount of space that the subject was occupying in the leading finance journals. There was no book that I could find suitable for such a course, so the initial reading list was comprised solely of original sources—professional, academic journal articles. Somehow, this worked, and students continue to pack into this course that is offered every spring at the University of Virginia.

It dawned on me that if this course proved useful to our students, perhaps I should write a book summarizing my thoughts on Behavioral Finance in book form so that others might consider offering a similar course at their institution. In this spirit, I dedicate this book to all of my students—past, present, and future.

I would especially like to thank my co-author, Sunit Shah, whose brilliance and attention to detail has hopefully made up for much of my unintended carelessness. I would also like to thank my students Francesca Archila, Mu Chen, Qichen Wang, Grace Chuang, Samantha Rivard, and Patrick Glading for help with this book. I would also especially like to thank my daughter Lindsay Burton Sheehan for her help with numerous aspects of the final version. My wife, Trish, and my daughter Elizabeth Burton have been a constant source of encouragement toward the completion of this enterprise. Finally, I am grateful to Wiley for their patience and support in getting this book to print.

Edwin T. Burton

My fascination with financial markets was born with the execution of my first trade at age 17. From that point forward, through forecasting macro trends, to conducting actuarial analysis on life settlements, to creating predictive models around movements of credit spreads, that interest has evolved into an ever-present curiosity as to how one might “beat the market.” Its juxtaposition against my academic training at the University of Virginia, presented mainly through the lens of the Efficient Markets Hypothesis, provided the contrast between the two sides of the Behavioral Finance debate. As such, this book has served as the perfect transition in my life in finance, from academic setting to practice, from theory to application, from avocation to full-time vocation.

To Ed's sentiments, I'd simply like to add my heartfelt appreciation: to Ed for the opportunity to join him on this endeavor, and for setting the structure and organization to the topic that allowed our ideas to flow; to all of the aforementioned students for all of their assistance in this book's creation; and to all of my friends and family, including my parents, Nitin and Suhasini Shah, my sister, Vaishali Shah, and my niece, Kirsi Shah Chinn, for their continued support along this journey, and throughout my life in general.

Sunit N. Shah

Introduction

Behavioral finance is a subtopic of the broader subject of behavioral economics. The behavioral in the name means that the behavior of participants in the actual economy is fundamentally different than what most academic theorizing normally assumes. Behavioralists argue that the predictions of economics, finance in particular, must be modified to account for how people actually behave in economic situations.

What is “commonly assumed” in economics and finance? The answer, in a word, is rationality. The usual implementation of rationality is to assume that individuals in the economy have a utility function that serves as a guide to what makes them happy, happier, and less happy. That utility function values various choices that a person could make subject to wealth, income, or whatever constrains expenditures for a particular person. The rational person maximizes utility (satisfaction, happiness, whatever the utility function is presumed to measure), staying within the bounds of what is possible as constrained by wealth and liquidity.

The utility-maximizing exercise by agents (persons, businesses, etc.) leads to predictable behavior and provides predictions about how markets function in the real world. For example, rational behavior by individuals, along with some other assumed conditions, implies that resources are allocated efficiently by the price mechanism both for the broader economy and for financial markets in particular. Prices perform a signaling function for the economy and, under these conditions, the prices direct agents to produce the “right amounts” and to buy and sell the “right amounts.” “Right amounts” means, roughly, that the economy does not waste resources. The result of the free interplay of market forces leads to results that are “right” in the sense that it is not possible to make anyone better off without making someone else worse off. This is the meaning of efficiency in economics and in finance.

This does not mean that the result of free markets is the best of all worlds—even in this highly theoretical exercise. The resulting income distributions might be “unfair,” and such unfairness requires a separate discussion. Behavioral economics and finance attack the foundations of the argument that markets allocate resources efficiently, long before arguments arise about fairness or the lack thereof. The behavioralists argue that markets may not produce efficient resource allocation, and it is generally possible to improve the economic position of some individuals without harming the economic position of other individuals.

Behavioral finance specifically questions the efficiency of financial markets. The prices of assets—usually the discussion is about stock prices—may not really reflect value, argue the behavioralists. Even simple ideas in finance, such as the idea that identical assets should sell at identical prices, have been called into question by the behavioralists. The critique of received finance theory by behavioral finance advocates is broad, deep, and extensive. Events in the real world of finance, such as the 1987 stock market crash and the 2008 financial collapse in Western economies, have added fuel to the fire. These events are difficult to reconcile with the efficient market point of view.

What follows is an effort to summarize the developments to date in the behavioral finance debate. Numerous behavioral finance books have been written for popular audiences in recent years, but they are mostly written by true believers who are attempting to persuade the reader that behavioral finance is the winner in its debate with more traditional finance. This is not such a book. We are not sympathetic to the behavioral finance position and this book takes a skeptical look at behavioral finance. But even skeptics, such as ourselves, are today overwhelmed by the mountain of evidence that is piling up for those who support the behavioral finance point of view and the unexplained stock market behavior that is increasingly difficult to reconcile with the efficient market view.

Thus, this book represents a skeptic's view with a grudging acceptance that, at this point, the advocates of behavioral finance seem to have the upper hand in the ongoing debate. This debate revolves around three main discussions: (1) noise trader theory and models; (2) research in psychological behavior pioneered by Kahneman and Tversky; and (3) serial correlation patterns in stock price data. There are other discussions in behavioral finance not captured in the three categories mentioned above, but the three topics above are all on center stage in the ongoing debate.

We begin with a discussion of the efficient market hypothesis, which is the central paradigm that behavioral finance seeks to attack. Then we move on to consider each of the three main areas of attack set out in the preceding paragraph. Finally, we conclude with thoughts about where this debate will go from here.

Additional resources for professors can be found on Wiley's Higher Education website.

PART One

Introduction to Behavioral Finance

CHAPTER 1

What Is the Efficient Market Hypothesis?

The efficient market hypothesis (EMH) has to do with the meaning and predictability of prices in financial markets. Do asset markets “behave” as they should? In particular, does the stock market perform its role as economists expect it to? Stock markets raise money from wealth holders and provide businesses with that money to pursue, presumably, the maximization of profit. How well do these markets perform that function? Is some part of the process wasteful? Do prices reflect true underlying value?

In recent years, a new question seems to have emerged in this ongoing discussion. Do asset markets create instability in the greater economy? Put crudely, do the actions of investment and commercial bankers lead to bubbles and economic catastrophe as the bubbles unwind? The great stock market crash of October 19, 1987, and the financial collapse in the fall of 2008 have focused attention on bubbles and crashes. These are easy concepts to imagine but difficult to define or anticipate.

Bubbles usually feel so good to participants that no one, at the time, really thinks of them as bubbles; they instead see their own participation in bubbles as the inevitable payback for their hard work and virtuous behavior—until the bubbles burst in catastrophe. Then, the attention turns to the excesses of the past. Charges of greed, corruption, and foul play accompany every crash.