BF and Investment process Flashcards
Barnewall Two-Way Model
2 simple investor type:
+ Passive investor
+ Active investor
Bailard, Biehl, and Kaiser Five-Way Model
include 2 axes:
+ confident - anxious axis
+ carefull - impetuos axis
Five investor types:
+ Adventurer
+ Celebrity
+ Individualist
+ Guardian
+ Straight Arrow
behavior investor type
+ passive preserver
+ Friendly Follower
+ Independent Individualist
+ Active Accumulator
home bias
under diversification and failing to invest outside the investor’s home country
gamblers’ fallacy,
thinking that there will be a reversal to long-term mean more frequently than actually happens
hot hand fallacy
hien tuong vao cau khi danh bac
lead individuals to incorrectly predict the continuation of a recent trend
anomalies
An anomaly may exist for only the short-run and disappear once it becomes known and exploited
Herding
occurs when a group of investors trade on the same side of the market in the same securities, or when investors ignore their own private information and act as other investors do
halo effect
investor transfers favorable company attributes into thinking that the stock is a good buy.
Passive Effect
+ who have not had to risk their own capital to gain wealth
+ gained wealth through long, steady employment and disciplined saving or through inheritance.
+ As a result of accumulating wealth passively, they tend to be more risk averse and have a greater need for security than their “active” counterparts.
+ Passive investors tend to have smaller economic resources than their active counterparts, which increases the security need while reducing risk tolerance
Active investors
+ risk their own capital to gain wealth and usually take an active role in investing their own money.
+ Active investors are much less risk averse than passive investors and are willing to give up security for control over their own wealth creation.
+ Active investors gather large amounts of information about their investments to establish the feeling of control over their investments.
+ This feeling can lead to overconfidence and they beleive that they are taking less risk than they truly are.
The adventurer
+ Confident and impetuous
+ Might hold highly concentrated portfolios
+ Willing to take chances.
+ Likes to make own decisions
+ Unwilling to take advice
+ Advisers find them difficult to work with
The celebrity
+ Anxious and impetuous (southeast quadrant)
+ Likes to be the center of attention
+ Might have opinions but recognizes limitations
+ Seeks and takes advice about investing
The individualist
+ Confident and careful
+ Independent and confident
+ Likes to make own decisions after careful analysis.
+ Good to work with because they listen and process information rationally
The guardian
+ Anxious and careful
+ Cautious and concerned about the future
+ Concerned with the future and protecting assets
+ May seek the advice of someone they perceive as more knowledgeable than
themselves
The straight arrow
+ Average investor
+ Sensible and secure.
+ Neither overly confident nor anxious
+ Neither overly careful nor impetuous
+ Willing to take increased risk for increased expected return
bias of Passive Preserver
+ Emotional: Endowment, loss aversion, status quo, regret aversion
+ Cognitive: Mental accounting, anchoring and adjustment
bias of Friendly Follower
+ Emotional: Regret aversion
+ Cognitive: Availability, hindsight, framing
bias of Independent Individualist
+ Emotional: Overconfidence, self - attribution
+ Cognitive: Conservatism, availability, confirmation, representativeness
Bias of Active Accumulator
+ Emotional: Overconfidence, self - control
+ Cognitive: Illusion of control
Five-Factor Process
(1) Investor goals -> determine the allocation to each layer.
(2) Asset selection
(3) The number of assets: risk averse -> hold large number
(4) If an investor believes she holds an information advantage (has information others do not have), more concentrated positions will be held
(5) If an investor is loss averse, the investor will hold larger cash positions to avoid the possible need to sell assets at a loss to meet liquidity needs
social proof
(1) Definition: individuals are biased to follow the beliefs of a group
(2) Solution:
+ Promote opposite opinion
+ Build the team with diversify sector experience
The reasons why investor invest in employer stocks:
(1) • Familiarity and overconfidence effects
(2) Naïve extrapolation of past returns: the company done well in the past -> employee is invest in
(3) Framing and status quo effect of matching contributions: if the imployer match the stock, the employee allocate to stock
(4) • Loyalty effects
(5) • Financial incentives:
The behavioral alpha process
(1) Step 1: Interview the client and identify active or passive traits and risk tolerance
(2) Step 2: Plot the investor on the active/passive and risk tolerance scale
(3) Step 3: Test for behavioral biases
(4) Step 4: Classify investor into a behavioral investor type
limitation of classifying investor into various types
(1) Individuals may exhibit both cognitive errors and emotional biases
(2) Individuals may exhibit characteristics of multiple investor types
(3) Individuals will likely go through behavioral changes as they age.
(4) Individuals are likely to require unique treatment even if they are classified as the same investor type because human behavior is so complex
(5) Individuals act irrationally at different times and without predictability.
the big picture of behavioral finance affect
(1) Affect adviser -client relations
(2) Affect portfolio construction
(3) Affect analyst forecast & overconfidence in forecasting skill
(4) Affect conducting research
(5) Affect committee decision making
(6) market behavior
6 behavior factors affect portfolio construction
(1) Inertia and default
(2) Naive Diversification
(3) Company stock: Investing in the familiar
(4) Excessive trading
(5) Home bias
(6) Behavioral Portfolio Theory
initia and default (description, how to fix, pros & cons)
- Description:
+ Happen for participant of DC plan
+ like status quo
+ not to change their asset allocation through the time - How to fix: autopilot (phi công tự lái)
+ automatically switch from risky asset to fixed income assets as the plan member near the intended retirement date - Disadvantages: it is one-size-fit-all solution -> not match the needs of specific sollution
naive diversification (description, how to fix, pros & cons)
- Description: use simple heuristic for allocate among available fund and framing bias
+ Participant use a 1/n naïve diversification strategy, dividing contributions equally among available funds irrespective of the underlying composition of the funds.
+ Participant use conditional 1/n strategy by allocating equally among their chosen subset of funds.
+ Participant may be to minimize future regret from one asset class beating the other
Company Stock: Investing in the Familiar
Including:
(1) Familiarity and overconfidence effects
(2) Naïve extrapolation of past returns
(3) Framing and status quo effect of matching contributions
(4) Loyalty effects
(5) Financial incentives
Familiarity and overconfidence effects
- Belong to company stock: investing in the familiar
- Underestimate risk because familiar with the emloying company and confidence in their estimate of company’s performance
Naïve extrapolation of past returns
- Belong to company stock: investing in the familiar
- companies whose stock has done well in the past may expect this performance to continue -> wish to hold company stock
Framing and status quo effect of matching contributions
- Belong to company stock: investing in the familiar
- When employer matching contributions are employer’s stock, employees tend to allocate their own contributions to employer’s stock
Loyalty effects
- Belong to company stock: investing in the familiar
- Employees may be willing to hold employer’s stock to assist the company, as they perceive it
Financial incentives
- Belong to company stock: investing in the familiar
- Employees may rationally invest in employer’s stock when there are financial incentives for them to do so (e.g., discount and tax benefits)
Excessive trading
Investors with retail accounts appear to be more active traders.
+ Frequent traders not only
(1) have higher transaction costs because of excessive trading
(2) but also experience opportunity losses because of the disposition effect.
+ Excessive trading appears to be driven by fear of regret/regret aversion and overconfidence
Home Bias
is the tendency of investors to invest a great portion of their funds in domestic assets. It is the result of information costs and behavioral biases, such as availability, confirmation, illusion of control, endowment, and status quo biases
Behavioral Portfolio Theory
Belong to behavioral bias of portfolio construction
How behavioral finance influences market behavior
- Market anomalies
- Momentum
- Bubble & crash
- Value stock outperform growth stock
The mechanic of behavioral finance affect Investment process
(1) Investors types
(2) Behavior factors affect adviser-client relations
(3) Behavior factors affect portfolio construction
(4) Behavioral finance and analyst forecasts
(5) Behavioral factors affect commitee decision making
(6) Behavioral finance influences market behavior
Characteristics of friendly follower
+ follow leads from their friends, colleagues, or advisers
+ want to be in the latest , most popular investments
+ tend to be cognitive
+ If emotional: regret aversion
Characteristics of passive preservers
+ focus on financial security + preserving wealth rather than taking risks to grow wealth
+ obsess over short-term performance
+ slow to make investment decisions because not comfortable with change
+ focus on taking care of their family members and future generations
+ tend to be emotional
+ if cognitive: anchoring, mental accounting
characteristics of independent individualist
+ strong-willed and independent thinkers
+ susceptible to acting on information
+ make an investment without consulting anyone
+ often resist following a financial plan
+ tend to be cognitive
+ if emotional: overconfidence, self-attribution
characteristics of active accummulators
+ aggressive, strong-willed, and independent
+ want to be heavily involved in the investment decision-making process
+ quick decision makers but may chase higher risk investments
+ Bias: overconfidence, self-control, and illusion of control
