Joel Benington's presentation (PDF) to my Bahaviorial Finance class

The basic idea of the talk was that as social animals, we have evolved to be trusting and helpful. It was a great presentation. Next time we will have to video it (hint hint!)

YouTube - Bob Brooks and Jonathan Godbey of the Christian Finance Faculty Association

YouTube - Bob Brooks and Jonathan Godbey of the Christian Finance Faculty Association: "A short video interview with Bob Brooks and Jonathan Godbey two of the founders of the Christian Finance Faculty Association from their inaugural meeting at the 2009 FMA conference in Reno."




Here is the link to the web site and presentation the speakers refer to in the interview. .

SSRN-Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances by John Beshears, Daniel Bergstresser

SSRN-Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances by John Beshears, Daniel Bergstresser: "Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances"

Interesting and important, but not all that surprising.

From the introduction:

"...a lack of financial sophistication may have made a subset of households more likely to take up of inappropriately risky mortgage products. In the 1992-2007 Surveys of Consumer Finances (SCF), interviewers rated both the ability of respondents to comprehend the financial questions in the survey and the degree to which respondents were suspicious of the interview....We find that in the 2004-2007 period, mortgage borrowers who exhibited lower comprehension and less suspicion in the SCF interview were more likely to have adjustable-rate mortgages (ARMs). The fact that these patterns are only present in 2004 and 2007 accords with the popular notion that the period immediately preceding the financial crisis witnessed an expansion of mortgage credit on terms that were not always fully understood by borrowers."

SSRN-Do Hedge Fund Managers Identify and Share Profitable Ideas? by Wesley Gray

To share or not to share that is the question. Shakespeare it is not), but when and if to share ideas is an important question.

How so? Suppose you have a great idea. It is an idea that you think could make you much money. You are not sure however. On one hand it could be a bad idea. But to gauge how good of idea (or to brag about it?), you have to tell others. But if you tell others, someone may take your idea.

So what do you do? Interesting question to say the least.

Wesley Gray examined this with respect to hedge fund trading. Now I must confess I am not entirely convinced of the metrics but a very interesting finding none-the-less.

SSRN-Do Hedge Fund Managers Identify and Share Profitable Ideas? by Wesley Gray:

".... Interestingly, these skilled investors share their profitable ideas with their competition. I test various private information exchange theories in the context of my data and determine the investors in my sample share ideas to receive constructive feedback, gain access to a broader set of profitable ideas, and to attract additional arbitragers to their asset market."

Behavioral Corporate Finance

Behavioral Corporate Finance is the main topic in class tonight. Here are some of the links we will be discussing:

Musings on Markets: Behavioral Corporate Finance 1: The Objective in Decision Making:: "When stock prices go up or down on the announcement of an action, there is some aspect of that action that is pleasing or troubling to investors. All too often, markets turn out to be right and managers to be wrong in the long term. In fact, managers who are convinced that their decisions will increase firm value are often operating under some of the same behavioral quirks that affect investors - they are over confident and systematically over estimate their abilities."

SSRN-Behavioral Corporate Finance by Hersh Shefrin:

"Managers and corporate directors need to recognize two key behavioral impediments that obstruct the process of value maximization, one internal to the firm and the other external. I call the first obstruction behavioral costs. Behavioral costs, like agency costs, tend to prevent value creation. Behavioral costs are the costs associated with errors that people make because of cognitive imperfections and emotional influences. The second obstruction stems from behavioral errors on the part of analysts and investors. These errors can create gaps between fundamental values and market prices. When they do, managers may find themselves conflicted, unsure of how to factor the errors of analysts and investors into their own decisions."

Behavioral Corporate Finance: A survey by Baker, Ruback and Wugler:

"Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that
managers are less than fully rational. It studies the effect of nonstandard preferences and
judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges,
and current evidence pertaining to each approach. Overall, the behavioral approaches help to
explain a number of important financing and investment patterns."

From FinanceProfessor:

Loughran and Ritter (2002, RFS) suggested that CEOs may not be concerned
about leaving money on the table in IPOs because the losses are netted
against the rises in stock price in the secondary market. Ljunqvist and
Wilhelm now test this and find that CEOs who are happy with the IPO are
less likely to switch investment bankers for the firm's SEO. Which does
fit the initial story. It should probably be noted that this line of
research (behavioral finance in a corporate setting) is really still in its
infancy. Stay tuned!

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=485302

Q&A: Is Market Efficiency the Culprit? - Fama/French Forum

Q&A: Is Market Efficiency the Culprit? - Fama/French Forum:

"Most investing is done by active managers who don't believe markets are efficient. For example, despite my taunts of the last 45 years about the poor performance of active managers, about 80% of mutual fund wealth is actively managed. Hedge funds, private equity, and other alternative asset classes, which have attracted big fund inflows in recent years, are built on the proposition that markets are inefficient. The recent problems of commercial and investment banks trace mostly to their trading desks and their proprietary portfolios, and these are always built on the assumption that markets are inefficient. Indeed, if banks and investment banks took market efficiency more seriously, they might have avoided lots of their recent problems."

and later:

"Fox concludes that passive investing is the right choice for almost all investors. My academic friends in behavioral finance (for example, Richard Thaler) almost always end up with a similar conclusion. In my view, this is an admission that the EMH provides a good view of the world for almost all practical purposes. At which point, I say I won."

The Hubris of Economics | The Big Picture

The Hubris of Economics | The Big Picture:

Barry Ritholtz discussing a WSJ piece ( Crisis Compels Economists To Reach for New Paradigm.)

"...an intriguing look at the problems of the the field of economics. It went, however, way too easy on both the profession and its practitioners. The article fails to ask some very basic questions about the soft science, and does not discuss the fundamental incompetency of many economists.

Given the failures of the profession — failing to anticipate the worst recession in decades, missing the warping effect of the housing boom, not recognizing the credit collapse until too late — a damning indictment of the dismal science might have been more appropriate"

He goes on to lay out many things that are wrong with the field (from politics, to over-reliance on assumptions, and over reliance on mathematical models, and good old fashioned over confidence.

Is he right? Unfortunately, yes. Maybe not completely, but to a degree he is.
How can it be that the political tilt of the so-called scientist influences the findings? How can basic assumptions (rationality and complete markets) be so often counter to empirical fact?

But in defense of the field, most economists I know always admit up front that the models are just that, models. Those that placed too much reliance in the models are nearly as much to blame.

I would definitely recommend reading the entire thing. While I am not in total agreement (possibly due to my own biases), he is pretty close to the truth which is very troubling.

Sidenote: Do I see an essay coming? Students, you have been warned ;)

Buffett Takeover Reduces Successor’s Need for ‘Amazing Insight’ - Bloomberg.com

Interesting take on Berhshire's takeover of Burlington Northern. I confess I did not consider this at all, but it makes sense. Buffett may be concerned that his successor would be left with a large cash holding that would have to be invested. This purchase, which fits his value investing mantra, effectively does away with the cash in one fast swoop.

Buffett Takeover Reduces Successor’s Need for ‘Amazing Insight’ - Bloomberg.com:

"“It’s kind of like dumbing down the asset base,” said Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of the hedge fund Ram Partners LP in Greenwich, Connecticut. “It suggests that the long-term opportunities have changed, and going forward Berkshire is not much more than a general call on the American economy, whereas in the past it was a call on Buffett’s investment acumen.”

The deal culminates a search by Buffett that sent him to Europe looking for possible acquisitions and lamenting in letters to shareholders that he and Vice Chairman Charles Munger couldn’t find companies they considered large enough to meaningfully add to annual earnings."

From the NY Times' Deal book:

"Mr. Buffett’s move on Tuesday to acquire the rest 77.4 percent of Burlington Northern that he did not already own is a major step for this relatively new railroad investor. But railroads fit Mr. Buffett’s value investing thesis as they possess strong competitive advantages and significant barriers to entry."

For more on the deal see The Wall Street Journals' Deal Blog, especially good is their diagram summarizing the deal.

Predictably Irrational: heursitics and coffee shops

Predictably Irrational:

"...what do we do when we need to make decisions but making them “correctly” is too time consuming and difficult? We adopt simplifying rules, which academics call heuristics, and these heuristics provide us with actionable outcomes that might not be ideal but they help us to reach a decision. In the case of coffee and other, similar decisions, one of the heuristics we often use is to look at our own past behaviors and if we find evidence of relevant past decisions, we simply repeat those"

In many ways this is yet another form of anchoring. BTW I highly recommend the Predictably Irrational Blog. It is predictably wonderful.

Food for Grooming - Freakonomics Blog - NYTimes.com

Food for Grooming - Freakonomics Blog - NYTimes.com:

"New research indicates that in addition to exchanging goods and services, monkeys adjust exchange rates as supply changes. Ronald Noe, a primate ethnologist, measured the grooming behavior of vervet monkeys in southern and eastern Africa. Among these monkeys, grooming is a hot commodity and is viewed by scientists as a form of “payment” for services. Noe found that when the number of food providers increased, each individual food provider received less grooming."

Common Objections to Capitalism - Art Carden - Mises Institute

Common Objections to Capitalism - Art Carden - Mises Institute:

"This article is based on Professor Carden's lecture 'Common Objections to Capitalism,' given at the 2009 Mises University Summer Program on July 30, 2009, and available as an MP3 download.

A lot of people object to what they call "capitalism," but their objections hold little or no water once they are examined critically. Let's consider some of the most common objections in turn."

This piece should be required reading (or ristening) for everyone who has ever doubted capitalism. It covers such topics as whether capitalism exploits the poor, encourages racism/sexism, is bad for the soul, encourages boom and busts, and hurts the environment. Good stuff.

Active Management Loses in Risk Study - WSJ.com

Active Management Loses in Risk Study - WSJ.com:

"The study by Morningstar Inc. found that, over the past three years, while about half of actively managed funds outperformed their respective Morningstar indexes -- which cover the nine different Morningstar investment styles -- only 37% did on a risk-, size- and style-adjusted basis. The numbers are similar for five and 10-year returns.

'It's not enough to beat an index in a way that [assumes more risk],' said Travis Pascavis, director of equity indexes at Morningstar. A riskier fund should provide greater returns, he added"

Gee, we just talked about this today in class.

HT to KimSnider the author of the Family CFO book we used last year in Finance 402.

(Lots of) Cash for Clunkers - Freakonomics Blog - NYTimes.com

(Lots of) Cash for Clunkers - Freakonomics Blog - NYTimes.com:

"Edmunds.com reports that its statistical analysis of the Cash for Clunkers program finds that the program generated only 125,000 extra new vehicle sales, meaning that the cost to the U.S. government was $24,000 for each of those new cars.

The reason the cost per incremental car is so high is that, according to Edmunds.com’s modeling, 82 percent of the vehicles purchased under the program would have been bought this year anyway, even without the subsidy"

Is anyone surprised?

Soros Launches Effort to Battle Free-Market Zeal | Newsweek Voices - Michael Hirsh | Newsweek.com

Soros Launches Effort to Battle Free-Market Zeal | Newsweek Voices - Michael Hirsh | Newsweek.com:

"...financier George Soros is announcing a $50 million effort to speed things along. This week Soros is gathering some of the leading practitioners of the market-skeptic school, who were marginalized during the era of 'free-market fundamentalism,' among them Nobelists Joseph Stiglitz, George Akerlof, Michael Spence, and Sir James Mirrlees. He's also creating an 'Institute for New Economic Thinking' to make research grants, convene symposiums, and establish a journal, all in an effort to take back the economics profession from the champions of free-market zealotry who have dominated it for decades"

First of all I love the sentence "...those marginalized....include Nobelists Joseph Stiglitz, George Akerlof, Michael Spence, and Sir James Mirrlees" Marginalized nobelists. Great! LOL.


But seriously, Soros has yet to convince me.

Do we need regulation? Yes. Free markets are not perfect and people do have an incentive to hide the truth, to create information asymmetries. However too much regulation and intervention is worse than too little. A free market system where people can take chances will win out over a centrally controlled system where who you know matters more than what you know.

Sure any free system will have painful excesses and bubbles, but these problems, as painful in the short run as they may be, must be weighed against the corruption and politics of any regulatory system. I am confident that if a proper accounting is done, the advantage will lie closer to the free market camp than the so called new economists believe.

George Soros, your success has earned you the right to say what you want and I respect your ideas, but in this case, I think history will show that you are on the wrong side of the market on this one.