Monday, August 24, 2009

The Psy-Fi Blog: The Special Theory of Behavioural Finance

While this maybe a bit strong, the piece will definitely be required reading for my Behavioral Finance Class this semester.

The Psy-Fi Blog: The Special Theory of Behavioural Finance:
"The Efficient Market Hypothesis (EMH) enshrines the spurious quest for precision...The beauty of classical financial economics is that it allows just this sort of modelling – once you've made the necessary assumptions needed to remove any vestige of real human behaviour.

Behavioural finance, however, offers no such comfort. Worse, it doesn’t allow you to make market predictions because there’s no overall model of human behaviour lying behind it. Many psychological biases pull us in different directions...Under the investment industry’s prime directive to generate returns the overriding importance of developing models that allow prediction has led to a focus on what can be modelled rather than what is real.

Better an unreal world we can simulate in a computer than a real one that we can’t, they say...."

BUT there is still a problem:

"The trouble is that this doesn’t get us any further in figuring out how to predict what’s going to happen next. Mostly EMH works and investing for the long haul is OK but occasionally it all goes horribly wrong and behavioural finance can tell us why but not when. "

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