Even the CFA Institute has been holding seminars on behavioral finance in the last ten years. A number of years ago, they devoted an issue of the Financial Analysts Journal to behavioral finance. Behavioral finance came about because of all of the anomalies that were observed when making predictions from Modern Portfolio Theory. Certain things should have happened, but they didn’t—and so researchers wanted to find out why.
What they discovered was a whole host of cognitive biases that human beings share. These biases are probably quite adaptive under most circumstances, but in investing they are not. (Cognitive biases are not just present in investing. Statisticians can document tons of behaviors that are not borne out by the numbers. They are adaptive for some reason other than trying to get the optimal outcome. For example, here is an article about a high school football coach who refuses to punt, always goes for it on fourth down, and uses only onside kicks. Being the first to do things differently is perhaps not psychologically comfortable, but his behavior is based on statistical data. Although he may sound like a crackpot, he’s already won a state football championship.)
Morningstar has a nice piece here on some of the most common cognitive biases that affect investors. The implication is pretty clear: control these behaviors and your results will improve. Not surprisingly, that’s exactly what our systematic processes are designed to do.
Hi,
Can you please send me the journal reference that was devoted to behavioral economics?
Thanks,
Maggie Baker