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9-1 behavioral finance and investment processes (3 how behavioral factors…
9-1 behavioral finance and investment processes
2 the uses and
limitations of
classifying investors
into types
general discussion
of investor types
barnewall two-way model
passive
greater need for security than tolerance for risk
smaller economic resources more likely passive
active
higher tolerance for risk
prefer to maintain contrl of own investments
BB&K five-way model
two axes
-level of confidence, confident-anxious axis
-method of actions,careful-impetuous axis
the adventurer: confident-impetuous
the celebrity: anxious-impetuous
the individualist: confident-careful
the guardian:anxious-careful
the straight arrow: center, sensible and secure
behavioral
investor
types
tottom up
too time-consuming or complex
behaviorall alpha
（BA） approach -
top-down essentially
a shortcut
1 interview and identify active or passive traits and risk tolerance
2 plot on the active/passive and risk tolerance scale
*certain biaes associated with behavioral investor type
3 classify investor into
a behavioral investor type
basic type / risk tolerance
level / primary biases
passive preserver
PP passive /
low / emotional
obsess over shor-term performance and slow to make decisions
endowment, loss aversion,
status quo and regret aversion
anchoring and adjustment
and mental accounting
more receptive to big picture advice
focus on what the money will accomplish - goals
friendly follower FF
passive / low to
medium / cognitive
without regard to current makket conditions
or the suitability
overestimate risk tolerance
availability, hindsight, and framing biases
regret aversion relates to herding behavior
education on the benefits of diversification
indepent individualist II
active /
medium to high /
cognitive
self-assured
acting on infor available to them
conservatism, availability, confirmation,
representativeness biases
overconfidence and self-attribution biases
regular educational discussions
active accumulator AA
active / high / emotional
high portfolio turnover rates
quick decision maker
overconfidence, self-control, and illusion of control
advisers to take control of the situation
limitations
behavior patterns are not
consistently demonstrated
may exhibit both cognitive errors and emotional biases
may exhibit characteristices of multiple investor types
will likely to go through behavioral changes as they age
likely to require unique treatment
act irrationally at different times and withou predictability
3 how behavioral factors affect
adviser-client relations
formulating financial goals
maintaining a consistent approach
investing as the client expects
ensuring mutual benefits
limitaions of
traditional risk
tolerance
questionnaires
inprecision
can vary as changing life stages or events
→re-evaluete periodically
interpret results to literally
→provide only broad gudelines for asset allocation
→may work better as diagnositc tool for institutional investors
may fail emotionally biased individuals
→the IPS that includes behavioral factors may result in that can adhere to
key result -
can comfortably adhere while fulfilling long-term goals
successful relationship
shares fundamental
characteristics
understand the client's financial goals and characteristics
maintain a systematic / consisitent approach
invest as the client expects
results communicated on a regular basis and effective manner
benefits both
4 how behavioral
factors affect
portfolio construction
inertia and default
most DC plan participants tend not to change asset allocation through time
stick with default options in terms of contribution rates and funds
→ autopilot atrategies
target date funds
naive
deversification
using simple heuristics to allocate among available funds and of framing bias
conditional 1/n strategy
regret
company stock:
investing in faliliar
familiarity and overconfidence effects
naive extrapolation of past returns
framing and status quo effects of matching contributions
loyalty effects
financial incentives
excessive trading
the disposition effect: trade too much - damaging returns - sell winners and hold on to losers
may be driven by fear of regret
by overconfidence
→ not only higher transaction cost but also opportunity losses
home bias
infor costs
availability, confirmation, illusion of control, endowment and status quo biases
behavioral portfolio theory
portfolios affected behavioral biases
formed as layered pyramids in which each layer is aligned with an objective
without regard for the correlations among these investments
failure to consider diversification benefits - mental accounting bias
multiple attitudes toward risk depending on which part of wealth considered