Behavioral finance and investment from Berkely

Why You Shouldn’t Trust Internet Comments | Science/AAAS | News

Why You Shouldn’t Trust Internet Comments | Science/AAAS | News:

In many areas the Wisdom of the crowds rules, but what is the crowd isn't as smart as we think?

 From Reddit:

"The “wisdom of crowds” has become a mantra of the Internet age. Need to choose a new vacuum cleaner? Check out the reviews on Amazon. Is that restaurant any good? See what Yelp has to say. But a new study suggests that such online scores don’t always reveal the best choice. A massive controlled experiment of Web users finds that such ratings are highly susceptible to irrational “herd behavior”—and that the herd can be manipulated."

Here is the abstract of the paper by  Muchnik, Aral, and Taylor. 

Why do I care?

I posted this on Facebook and then decided it was enough finance related to post here as well.

Yes, it is their money (donated by Phil Knight). Yes, they can spend their money in anyway they see fit. No, they are not the only ones to go "overboard".

I concede my "overboard" tends to be significantly less than other people's "just right". And I even bet that the fancy "football complex" will help recruitment (opulence sells), but its almost mind boggling excess sends another message and frankly makes me feel at least a little guilty about liking college football (sports).

The worst thing is I don't know why I feel guilty. It's not the sports aspect; I would feel just as guilty if the building were a new School of Business/Science/Education/Hospital or orphanage. It is the excess.

And yet why? If they want to have a bonfire and burn their money, it is none of my business (ignoring money supply and pollution effects). So why do I care? Strike up another one to behavioral finance I guess. http://www.nytimes.com/2013/08/03/sports/ncaafootball/oregon-football-complex-is-glittering-monument-to-ducks-ambitions.html?_r=0

 

 

 

Great lessons from 25IQ (and Daniel Kahneman) | 25iq

 Great stuff! 

Great stuff!  A Dozen Things I’ve Learned About Investing from Daniel Kahneman | 25iq:

 A Dozen Things I’ve Learned About Investing from Daniel Kahneman

1. “Many individual investors lose consistently by trading, an achievement that a dart-throwing chimp could not match.” Leonard the Wonder Monkey will beat a muppet in an investing contest. Not only will muppets lose to a dart throwing monkey, they will do worse than chance would dictate, especially after fees because of certain behavioral biases.

Read the whole list:  here.

Brain sets prices with emotional value

Brain sets prices with emotional value:

Not super surprised by this one:

"...after a series of experiments in which subjects were asked to modify how they felt about something either positively or negatively, the Duke group is arguing that emotional and economic calculations are more closely related than brain scientists had realized. The study appears July 3 in the Journal of Neuroscience."

earlier in article:

"You might be falling in love with that new car, but you probably wouldn't pay as much for it if you could resist the feeling. Researchers at Duke University who study how the brain values things—a field called neuroeconomics—have found that your feelings about something and the value you put on it are calculated similarly in a specific area of the brain."

Forget self-denial: Key to richer, healthier life is a good imagination - Red Tape

Forget self-denial: Key to richer, healthier life is a good imagination - Red Tape:


The "He" is Joesph Kable from Penn.

"Recently, his research took an inspirational turn. He found that subjects whose brains show added activity when imagining the future also make better decisions about money. Kable suspects that consumers who can really, viscerally imagine how great that new car will smell when they drive off the lot, or how excited they will be when getting the keys to a new home, have a much easier time saving money. Conversely, those who have dull imaginations tend to live in the present, and blow their cash on payday"

Mercury News interview: Meir Statman, Santa Clara University professor of finance - San Jose Mercury News

Finance (Photo credit: Tax Credits)

Mercury News interview: Meir Statman, Santa Clara University professor of finance - San Jose Mercury News:

"Santa Clara University finance professor Meir Statman believes that American employers should be forced to set up retirement plans for their workers for one simple reason: "People are stupid," he said.

Statman, an expert in behavioral finance, includes himself among people who sometimes make stupid financial decisions."

Statman's book What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions is one of my all time favorites.

Here is an audio interview I did with him a few years ago:  podcast with Meir Statman.

The Honest Truth About Dishonesty by Dan Ariely

RSA and Ariely together?  YES! 

Nova's Mind over Money

Interesting look at behavioral finance from PBS' Nova:


Good stuff!

 

aiCIO - A Neurology Lesson for Money Managers

Chief Investment Officer-CIO - A Neurology Lesson for Money Managers:

Nice short list (8 points) on how neuroeconomics effects money managers from Paul Zak.

"The crossover applications between neurology and economics don’t end there. In fact, an entire discipline has sprung up in their midst: neuroeconomics. Two leaders in this field have teamed up and crafted a list of the eight crucial takeaways from neuroeconomics for money managers.

According to Paul Zak, the head of a center for neuroeconomics at Claremont Graduate University, and Steven Sapra, a finance professor the University of Southern California, these are the key points of neuroeconomics for money managers:"

The first three points:

1. Anticipating rewards (you can get addicted to the "rush")
2. Balancing risks (you tend to take bigger chances after some success)
3. Wait for it (Delaying gratification can be difficult)

Great article.  Definitely will appear on some tests this semester! :)

Take the money: Why we make better financial decisions for strangers than family

Take the money: Why we make better financial decisions for strangers than family

This one should not really surprise anyone and is essentially the logic behind my recent test question of "what is the role of a financial planner in the face of investors prone to behavioral biases".

"They found participants were more likely to select a smaller immediate reward than delay for a larger pay-off both for themselves and for beneficiaries they were more closely related to. The decisions got progressively less impulsive and steadily more rational as the family connection became more distant. The most rational economic choices were made on behalf of complete strangers.

The study, published in the online journal PLOS ONE, is the first to show that decisions taken on behalf of others are affected systematically by the closeness of the relationship...."

NBA Players Forced to Save Toward Retirement for First Time - Bloomberg

English: Chicago Bulls Scottie Pippen 1995 (Photo credit: Wikipedia)

NBA Players Forced to Save Toward Retirement for First Time - Bloomberg:

To combat the near epidemic problems of professional athletes going broke after failing to safe for tehir retirement, the new NBA agreement includes a forced saving plan:

"Beginning next season, players also will surrender 5 percent to 10 percent of their salary for retirement. They automatically will be enrolled in the program and would have to opt-out to keep from participating in the plan, Klempner said."

Note how the plan makes use of defaults (lesson learned from behavioral finance!)

Didn't know lack of saving was a problem? Here from the article:

"Former NBA players Scottie Pippen, Latrell Sprewell and Antoine Walker are among retired professional athletes who have experienced financial difficulty after careers in which they earned tens of millions of dollars. Walker filed for bankruptcy after being paid more than $100 million over 12 years in the NBA.


“It’s a start,” player agent Keith Glass said in a telephone interview. “It does force you to save something, and that’s a good idea.”

Futurity.org – In tool trade, chimps reveal a quirky bias

Futurity.org – In tool trade, chimps reveal a quirky bias:

The endowment effect essentially says that you value something you own more than it is worth from an outside perspective.  Now it appears that chimps suffer the same bias:

"Drawing on prior theoretical work by Jones on the evolution of seemingly irrational behaviors, Brosnan and Jones found consistency between chimpanzees and humans with respect to the existence of the endowment effect and, more importantly, showed that variations in the prevalence of the effect could be predicted."

Related articles

• Endowment effect in chimpanzees can be turned on and off

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• Research shows endowment effect in chimpanzees can be turned on and off

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Why Do Individuals Exhibit Investment Biases? by Henrik Cronqvist, Stephan Siegel :: SSRN

Why Do Individuals Exhibit Investment Biases? by Henrik Cronqvist, Stephan Siegel :: SSRN

Abstract:
"We find that a long list of investment biases, e.g., the reluctance to realize losses, performance chasing, and the home bias, are "human," in the sense that we are born with them. Genetic factors explain up to 50% of the variation in these biases across individuals. We find no evidence that education is a significant moderator of genetic investment behavior. Genetic effects on investment behavior are correlated with genetic effects on behaviors in other domains (e.g., those with a genetic preference for familiar stocks also exhibit a preference for familiarity in other domains), suggesting that investment biases is only one facet of much broader genetic behaviors. Our evidence provides a biological basis for non-standard preferences that have been used in asset pricing models, and has implications for the design of public policy in the domain of investments."

 
Oh the essays questions I could/will write! 

 
Cite:

Cronqvist, Henrik and Siegel, Stephan, Why Do Individuals Exhibit Investment Biases? (February 19, 2012). Available at SSRN: http://ssrn.com/abstract=2009094

Study: Consumers Keep Up -- or Down -- with the Joneses During Recession - Duke's Fuqua School of Business

           (Photo credit: Anders V)Study: Consumers Keep Up -- or Down -- with the Joneses During Recession - Duke's Fuqua School of Business:


It has long been a question as to why spending is reduced in a recession for many whose income seemingly has not fallen (or at least not enough to warrant income based cutbacks). Now we may have the answer thanks to Wagner Kamakura and Rex Du whose paper suggests that this reduction of spending is a result of those who are spending as a means of flaunting their wealth (i.e "Keeping up with the Joneses") don't need to spend as much to do so when the Joneses have been forced to cut their spending.

"Non-essential goods like jewelry, clothing and travel maintain their attractiveness regardless of the state of the economy," said Wagner Kamakura, marketing professor at Duke's Fuqua School of Business and lead author of the study. "But the positional value of non-essentials is reduced during recession.

"When households affected by recession spend less on positional goods, households not directly affected by recession -- even though their overall consumption budgets may remain constant -- can follow suit and still maintain their social status. Those households whose budgets are not significantly impacted by recession may choose to divert more money into savings.

a look-in to the paper itself which is forthcoming in the Journal of Consumer Behavior:

"' Our basic research question is: For any given level of consumption budget, how would a household’s expenditure pattern (i.e., category budget shares) differ, depending on whether the economy is in recession or not? Standard economic models would suggest that for the same amount of total expenditures, category budget shares would remain unchanged. A key assumption of these standard models is that the utilities a household derives from various commodities at different levels of expenditure are independent of economic conditions. For example, consumers should enjoy jewelry in a recession as much as they do in normal economic times.....in this study, we depart from the standard economic assumption, arguing that the utilities a household derives from various commodities could vary systematically, depending on whether the economy is in recession or not. We postulate that people care about their relative position in a society when it comes to expenditures in certain categories. In a recession, their desire to spend in these “positional” categories will decrease, because there is no longer a need to spend as much to maintain the same social standing when others have reduced their expenditures."

Wow, I wish I had thought of that!

That said, I would also suggest that at least some of the reduced spending may be explained, not so much by a drop in income, but by an increase in the variance of the income ("I have a job not, but my future now looks more uncertain so I better not spend so much.")

Related articles

• Why are wealthy consumers less likely to buy luxuries during a recession? (eurekalert.org)
• What is meant by 'keeping up with the Joneses'? (examiner.com)

Great apes make sophisticated decisions: Research suggests that great apes are capable of calculating the odds before taking risks

Great apes make sophisticated decisions: Research suggests that great apes are capable of calculating the odds before taking risks:

Researchers have demonstrated that apes can evaluate risks and rewards and that apes are risk averse (they demand a greater payoff to take on risky "investments").

From Science Daily reporting on a paper by Daniel Huan (and others)

"The apes were presented with two banana pieces: a smaller one, which was always reliably in the same place, and a larger one, which was hidden under one of multiple cups, and therefore the riskier choice.....The researchers also found that the apes went for the larger piece -- and risked getting nothing at all -- no less than 50% of the time. This risky decision-making increased to nearly 100% when the size difference between the two banana pieces was largest."

Maybe we have something to learn from monkeys after all: Monkey see, monkey do??

Related articles

• Decision Making By Great Apes Could Impact Human Studies (medicalnewstoday.com)
• What Would You Do If All Odds Are Against You? (janwong.my)

Self imposed contraints back to the time of the ancient Greeks.

TEDtalksDirector's Channel - YouTube:


While a rational person would not need to impose constraints on ourselves, many of us need to.  In Behavioral finance we often talk about the seeming irrationality of them but all acknowledge both using them and them working.  In his TED talk, Dan Goldstein goes further into this topic and explains why we impose constraints on ourselves (100 calorie packs, Stickk.com, even budgets), how framing matters, and even how the discount rates we use affects our decision making.

While the entire talk is good, I especially enjoyed the discussion of Odysseus having himself tied to the mast to avoid the Sirens. (btw here are two pictures of that event: a PG version and a R version (nudity). )

Daniel Goldstein makes tools that help us imagine ourselves over time, so that we make smart choices for Future Us.

Brainwaves on the economy translated into a fine science - The National

Brainwaves on the economy translated into a fine science - The National:

" The neuroeconomic revolution has passed some key milestones recently, notably the publication last year of the neuroscientist Paul Glimcher's book Foundations of Neuroeconomic Analysis - a pointed variation on the title of Paul Samuelson's 1947 classic, Foundations of Economic Analysis, which helped to launch an earlier revolution in economic theory. And Mr Glimcher himself now holds an appointment at New York University's economics department.

To most economists, however, Mr Glimcher might as well have come from outer space. After all, his doctorate is from the University of Pennsylvania school of medicine's neuroscience department."



I finally got around to watching his presentation at the Nobel Conference from back in October. HIGHLY HIGHLY recommended. It is STAGGERINGLY good!

 

Related articles

• The Dawn of Neuroeconomics (bigthink.com)
• The Neuroeconomics Revolution - Robert J. Shiller (logicamp.wordpress.com)

Freakonomics » What Makes a Rogue Trader Tick? A Q&A with FT Columnist John Gapper

Freakonomics » What Makes a Rogue Trader Tick? A Q&A with FT Columnist John Gapper

"In his new e-book, How to Be a Rogue Trader, Financial Times columnist John Gapper explains why this story has become so familiar over the years. As he puts it, the rogue trader is a species of sorts within the world of finance, a special breed with certain behaviors and characteristics that are consistent through time. Gapper delves into evolutionary biology and the research of Daniel Kahneman to better understand the nature of men like Nick Leeson, Joe Jett, and Jerome Kerviel.

Q. You start with a discussion of evolutionary biology to examine the motivations of a rogue trader. Explain that.
A. I found the research fascinating, these evolutionary studies of the ways that species adjust their behavior when foraging for food. When they’re comfortable, they behave with risk aversion — they’ll go to the place that is the most reliable, even if it doesn’t offer the best returns. But when their survival is threatened, they will go to the riskiest places.
Q. You also spend a bit of time discussing the work of Daniel Kahneman. ....
A. The Kahneman work is classic in the way that it explains how we react to gain and loss. It did strike me, the degree to which the behavior of traders falls in line with his work. They are hungry in a very basic sense. Kahneman talks about how moving the reference point changes people’s attitude to risk. If you look at a trading floor in those terms, you’re setting up an incentive system so that traders are eager to take risks."

I predict my students will LOVE this one!

Related articles

• The Folie De Grandeur Of Rogue Traders (forbes.com)
• Why rogue traders will never disappear (blogs.reuters.com)
• Sam Harris interviews Daniel Kahneman (3quarksdaily.com)
• How to Dispel Your Illusions (nybooks.com)

Hat tip to Ismail Ali Mani for the link!!! 

Do Nice Guys Finish Last? | Wired Science | Wired.com

Image via WikipediaDo Nice Guys Finish Last? | Wired Science | Wired.com:

"Nice guys really do finish last, or at least make significantly less money. According to a new study in the Journal of Personality and Social Psychology by Beth A. Livingston of Cornell, Timothy A. Judge of Notre Dame, and Charlice Hurst of the University of Western Ontario, levels of “agreeableness” are negatively correlated with the earnings.

The article goes on to describe "disagreeable" not as downright mean or evil but in a way I would describe as more "self interested" than others.

From the article:

"...these disagreeable people do consistently exhibit one special trait: They are willing to “aggressively advocate for their position during conflicts.” While more agreeable people are quick to compromise for the good of the group...their disagreeable colleagues insist on holding firm"

So what? Well like the cliche a squeaky wheal gets oiled, these disagreeable people get paid:

"The researchers summarize their data: Overall, across the first three studies, men who are one standard deviation below the mean on agreeableness earn an average of 18.31 percent ($9,772) more than men one standard deviation above the mean on agreeableness. Meanwhile, the “disagreeableness premium” for women was only 5.47 percent ($1,828). Thus, the income premium for disagreeableness is more than three times stronger for men than for women."

BTW the article also confirms previous studies that show women are paid less for same jobs as men.

Related articles

• Nice Guys Never Win (Neither Do Mean Girls) (freakonomics.com)
• Nice guys earn less, study finds (cnn.com)
• Nice guys do finish last - and they earn less (independent.co.uk)