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Behavioural Finance - Coggle Diagram

- - - - limited self control (p.300)
  - - - Laibson, D. I., A. Repetto, and J. Tobacman, 1998, “Self control and saving for retirement,”
  - - - Benartzi, S., and R. Thaler, 2001, “Naïve diversification strategies in defined contribution saving plans,”
        
        1/n strategy: divide contributions evenly across funds offered (slides)
      - Huberman, G., and W. Jiang, 2006, “Offering vs. choice in 401(k) plans: Equity exposure and number of funds,”
  - - - employees must negatively elect non-participation in a company retirement savings plan
        
        footnote 42
        
        Madrian, B. C., and D. F. Shea, 2001,
        “The power of suggestion: Inertia in 401(k) participation and savings behavior,”
    - - persuading people to save a sufficient amount for a properly funded retirement (w commitment mechanism)
        
        footnote 46
        
        Thaler, R. H., and S. Benartzi, 2004, “Save more tomorrow: Using behavioral economics to increase employee saving,”
      - results on p.311
  - - - interventions to improve financial literacy explain only 0.1% of the variance in financial behaviors studied
  - - - Veenhoven (1988): absolute income helps people meet important and universal needs, anything above basic needs being less fulfilled by money(slides)
      - Relative income: one's earnings in relation to average income (slides)
        
        social peers as a reference point
      - lyubomirsky with evidence based happiness increasing strategies (slides), eg expressing gratitude and cultivating optimism
- - - - we tend to give more to people we consider deserving, cultural background also has an effect
      - Tendency for dictator to give more when endowment was larger
  - - - Decomposing trust from altruism and reciprocity from altruism or inequality aversion is critical to obtaining empirical information that can guide the process of constructing models that can increase the empirical validity of game theory
    - - 30/32 game trials resulted in a violation of the results preducted by standard economic theory. (slides)
  - - - We show that a model which combines heterogeneous fairness concerns with decision errors correctly predicts the comparative static effects of changes in competition
  - - - In our experiments the crowding out effect is so strong that the incentive contracts are less efficient than contracts without any incentives. Principals, nonetheless, prefer the incentive contracts because they allow them to appropriate a much larger share of the (smaller) total surplus and are, hence, more profitable for them.
  - - - Janis, I. L., 1982, Groupthink: Psychological
        Studies of Policy Decisions and Fiascoes,
    - - Milgram experiment
    - - The Asch conformity experiments consisted of a group “vision test”, where study participants were found to be more likely to conform to obviously wrong answers if first given by other “participants”, who were actually working for the experimenter.
  - - - Preferences exhibit large heterogeneity across and within countries, partly systematic and linked to individual and aggregate level characteristics
  - - - women will be more socially-orientated (selfless), and men more individually-orientated (selfish)
  - - - Mauss identified 3 obligations: giving, receiving (accepting the social relationship) and reciprocating (which demonstrates the recipient)
    - - employment relationships are shaped by mutual expectations and trust between workers and employers rather than purely economic considerations. (slides)
  - - - Regions with greater social capital exhibit more advanced financial markets, attributing this to lowered transaction costs and enhanced trust among participants. This research underscores the signicant role of social capital in facilitating financial development by fostering a conducive environment for financial transactions. (slides)
      - slides for more studies on social capital
  - - - Intrinsic: do something without any external rewards, so an internal desire
      - Instrumental: pragmatic, done to lead to a desired outcome
      - Extrinsic: behaviour that is driven by external reward
    - - Autonomy: overall psycholigcal liberty and freedom of internal will
      - Competence: sense of mastery
      - Relatedness: sense of purpose
- - - - https://peeps.unet.brandeis.edu/~yanzp/Study%20Notes/Irrational%20Exuberance_Shiller.pdf
      - Emphasizing the psychological factors in driving market volatility
    - - The authors suggest a psychoanalytic approach focusing on unconscious phantasy relationships, states of mind, and unconscious group functioning can explain some outstanding questions about financial bubbles which cannot be explained with mainstream economic theories
    - - Effect of emotional drives on economic factors
  - - - Ackert, L.F., and B. K. Church, 2001, "The effects of subject pool and design experience on rationality in experimental asset markets"
        
        Our main findings are: (i) price run-ups are modest and dissipate quickly when traders are knowledgeable about financial markets and have design experience; (ii) price bubbles moderate quickly when only a subset of traders are knowledgeable and experienced; and (iii) individual forecasts of price are not consistent with the predictions of the rational expectations model in any market.
    - - Lei, V., C. Noussair, and C. Plott, 2001, "Financial bubbles: Excess cash, momentum and incomplete information" (footnote 33)
        
        The results suggest that the departures from fundamental values are not caused by the lack of common knowledge of rationality leading to speculation, but rather by behavior that itself exhibits elements of irrationality. Much of the trading activity that accompanies bubble formation, in markets where speculation is possible, is due to the fact that there is no other activity available for participants in the experiment
  - - - The relatively small market responses to such news, along with evidence that large market moves often occur on days without any identifiable major news releases, casts doubt on the view that stock price movements are fully explicable by news about future cash flows and discount rates.
  - - - Measures the relationship between market valuation and intrinsic value: estimates whether a business or market is overvalued or undervalued
      - https://www.investopedia.com/terms/q/qratio.asp
    - - The Buffett Indicator (aka, Buffett Index, or Buffett Ratio) is the ratio of the total United States stock market to GDP. The Buffett Indicator expresses the value of the US stock market in terms of the size of the US economy. If the stock market value is growing much faster than the actual economy, then it may be in a bubble.
      - https://www.currentmarketvaluation.com/models/buffett-indicator.php
    - - These ratios compare the current price of an asset to various fundamental measures of its value, such as earnings, book value, or cash flow. High and sustained price-to-fundamentals ratios can indicate that an asset is overvalued and potentially in a bubble. (Keats)
    - - valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.
      - https://www.investopedia.com/terms/c/cape-ratio.asp
    - - The ratio of home prices to annualized rent in a given location: estimate if its cheaper to rent or own property
      - https://www.investopedia.com/terms/p/price-to-rent-ratio.asp
    - - The CBOE Volatility Index (VIX), also known as the Fear Index, measures expected market volatility using a portfolio of options on the S&P 500: Gauge market sentiment and the degree of fear among market participants
      - https://www.investopedia.com/terms/v/vix.asp
  - - - As a result, investors might follow the majority, creating a cascade effect where even small trends can amplify and lead to significant market movements. (Keats)
    - - In the paper "A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades", Bikhchandani, Hirshleifer, and Welch (1992) developed a model demonstrating how information cascades can lead to rapid and widespread adoption of behaviours or beliefs. They showed that when individuals rely heavily on the observed actions of others, small initial advantages or random events can trigger a cascade, causing many to make the same choice regardless of their private signals.
  - - - Reputational: Scharstein and Stein (1990)
- - - - overconfidence is not universal
      - Study shows questions reflected marked overconfidence in the extreme ranges (p.110)
  - - - 82% of students rated themselves in the top 30% of their group on driving safety
  - - - Subjects made significantly higher bets when facing the schnook (P.111)
  - - - Planning fallacy in financial budgeting (Slides)
    - - Investors exhibiting excessive optimism are likely to overvalue assets, underestimate risks, and expect higher returns on investments than what might realistically be achieved (keats)
    - - cognitive bias that leads individuals to believe they are less likely to experience negative events and more likely to experience positive events compared to others (Slides+studies)
  - - - foonote 18
    - - footnote 19: Lundeberg, M. A., P. W. Fox, and J.Punccohar, 1994, “Highly confident but wrong: Gender differences and similarities in confidence judgments,”
    - - footnote 21: Bhandari, G., and R. Deaves, 2006, “The
        demographics of overconfidence,”
  - - - how people come up with explanations for the causes of actions and outcomes (p.114)
        
        footnote 26: See Plous, S., 1993, The Psychology of Judgment and Decision-making (McGraw-Hill, New York), for a full discussion.
    - - tendency for people to attribute successes or good outcomes to their own abilities, while blaming failures on circumstances beyond their control
        
        footnote 27
    - - Pushes people into thinking they "knew it all along"
    - - tendency to search out evidence consistent with one's prior belies and to ignore conflicting data
  - - - Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent.
      - Explained by overconfidence: excessive trading and financial underperformance
    - - Found that less experienced investors tend to be more overconfident than experienced investors (slides)
  - - - tendency to believe they are better than others or rank higher than others
        
        underscores overconfidence by assuming a normal distribution of abilities (slides)
    - - having excessive confidence in the accuracy of one's beliefs or predictions
      - Measure of overconfidence as people often exhibit miscalibration in their judgements, tending towards overprecision (slides + study in slides)
      - Ben-David, Graham and Harvey (2003) (Slides): basically actual market returns fall outside of executives predictions
    - - tendency to overestimate ones actual abilities
        
        Barber and Odean (2000)
        
        Statman, Thorley and Vorkink (2006) (slides)
  - - - unconscious incompetence, conscious incompetence, conscious competence, and unconscious competence. (Keats)
    - - participants did not start overconfident but rapidly became so after a few experiences: suggests a little learning can be a dangerous thing, as beginngers confidence can quickly race ahead of their actual performance
  - - - we learn by consequences; behaviour followed by pleasant consequences is repeated and vice versa (slides)
- - - - This reference point serves as a mental benchmark for evaluating gains and losses, fundamentally altering the perceived value of an outcome. (keats)
  - - - A review of the experimental evidence results of a new experiment confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion or losses of low probability
  - - - the value that an individual assigns to such objects as mugs, pens, binoculars, and chocolate bars appears to increase substantially as soon as that individual is given the object. The apparently instantaneous nature of the reference point shift and consequent value change induced by giving a person possession of a good goes beyond previous discussions of the endowment effect, which focused on goods that have been in the individual's possession for some time
  - - - Thaler, R. H., 1999, “Mental accounting
        matters,”
        
        3 aspects: decision framing, assignment of accounts, frequency of account evaluation
    - - exerts self control
        
        footnote 35: Self-control has been used to explain why some investors seem to prefer cash dividend payments over capital gains. See Shefrin, H. M., and M. Statman, 1984, “Explaining investor preference for cash dividends"
    - - Tendency to avoid selling losers
        
        Shefrin, H., and M. Statman, 1985, “The disposition to sell winners too early and ride losers too long: Theory and evidence,” https://www.jstor.org/stable/2327802?seq=12
        
        In particular, we find that tax considerations alone cannot explain the observed patterns of loss and gain realization, and that the patterns are consistent with a combined effect of tax considerations and a disposition to sell winners and ride losers
      - suggests decisions often have path dependence to them
    - - other limitations:
        
        unclear what a gain or loss represents in any given situation (Barberis (2013), Keats)
    - - includes strategies like hedonic editing, where individuals manipulate the mental accounting of outcomes to make them more pleasurable or less painful. (Keats) segregate gains and integrate losses because the value function exhibits diminishing sensitivity as the magnitutde of a gain or loss becomes greater (slides)
  - - - Linear models play a pivotal role in many theories of finance due to their simplicity, analytical tractability, and the intuitive insights they provide into complex financial relationships. One of the most prominent examples of this is the Security Market Line (SML) of the Capital Asset Pricing Model (CAPM).
    - - The logarithmic utility function captures the idea of diminishing marginal utility of wealth, which is a cornerstone of economic theory. This means that the satisfaction (utility) an investor gains from each additional unit of wealth decreases as their wealth increases. Logarithmic functions naturally model this behaviour, aligning with observations of risk-averse behavior among investors.
- - - - A market in which prices always "fully reflect" available information is called "efficient."
    - - Consistently outperforming the market on a risk-adjusted basis is not possible, as all available information is already reflected in asset prices (Fama, 1970)
      - Beating the market means achieving investment returns that exceed those of a benchmark index or the overall market average on a risk-adjusted basis. This indicates that an investor has outperformed not merely by taking on additional risk, but by earning higher returns relative to the level of risk undertaken
        
        produce more returns than is predicted by risk
      - Malkiel publishes findings from a unique data to measure specific impact of surviorship bias: if anything active investors performance was overstated in earlier work, given we can only observe surviving funds (as unsuccessful funds leave the market) (slides)
      - Active managers tend to underperform the index
  - - - Carhart (1997) four factor model
    - - Individual stories or observations of market behaviour that appear to contradict EMH. Individual observations do not necessarily represent the overall behaviour of the market
      - EG. Cuba and Entremed (slides)
    - - Comprehensive and rigorous analysis of data that aims to establish the presence of predictable patterns in the market. more reliable and objective way of evaluating the presence of anomalies to the EMH
  - - - social forces
        
        Shiller, R.J., 1984, "Stock prices and social dynamics" p.457
      - Shillers model (p.68) Shiller, R.J., 1984, "Stock prices and social dynamics"
        
        smart-money traders
        
        model assumes that some investors want to remain invested in the market even if prices are higher than they should be
    - - any pricing gap between a relatively expensive security and a relatively cheap one will be vigorously capitalized on
      - textbook arbitrage
    - - Fundamental risk
        
        potential for rational revaluation as new information arrives
        
        mitigate: use of substitutes and spread trading (p.72)
      - Noise trader risk
        
        Noise
        
        noise is not just background disturbance but plays a crucial role in the functioning of financial markets. It allows for trading to occur more frequently because noise traders provide liquidity to the market by trading on misinformation or speculation rather than on fundamental information. (keats) (Black, 1986 to read in exam if needed)
      - Implementation costs
  - - - Beat average return of the market, involves stock picking
    - - match the return of the market replicates or samples the index