This is a presentation that took place 2/14/14 at the CFA Texas Symposium by Josh Chisari Ph.D, titled “Historical Precedents for Persistently Low US Inflation: Their Causes and Implications for Contemporary Times.” The full text can be found below after a section of highlights.
Emotion driven investing behaviors and common pitfalls
- Short-term performance driven flows
- Misperception of risky assets
- Investors tend to buy at the peak and sell at the troughs of an alpha cycle
- Consumer confidence vs. forward returns
Behavioral Finance investing
- Behavioral finance explained
- Why it works
- Product highlights
The common pitfalls of emotion driven investing
Behavioral Finance explained
What is behavioral finance?
Theory: Behavioral finance is the study of how psychology impacts the financial decision making process
Implications: By better understanding investor behavior, it is possible to identify and capitalize on emotion driven market anomalies
Theory of Behavioral Finance – Nobel Prize Winner
Daniel Kahneman – the first “non-economics major” to win a Nobel Prize in Economics in 2002
Validation that emotion can effect the financial decision making process
“Prospect Theory”
- Investors feel the pain of a loss, 2-3 times as much as they confer a benefit from a gain
… Human emotions impact the decision making process!
Common pitfalls
- Overconfidence
- Anchoring
- Representativeness
- Confirmation bias
- ADD bias
- Herd mentality
Overconfidence
Overestimating or exaggerating one’s ability to successfully perform a particular task
- 81% of new business owners think their business has at least a 70% chance of success, but only 39% think any business identical to theirs would likely succeed
- 68% of lawyers in civil cases believe their side will prevail
- 80% of students think they will finish in the top half of their class
- Analysts are over-confident in their earnings estimates of companies they like, however, their estimates are revised 2x more frequently in the second half of the year to play “catch up” to reality
Ask yourself: “What am I missing?”
Anchoring
Human tendency to rely too heavily, or “anchor,” on historical data when making decisions
Apple Inc. (NASDAQ:AAPL) ’s stock performance since 2004 provides an example of Behavioural Finance anomalies (Anchoring/Overconfidence) where analysts under react to new information when revising forecasts
Apple Inc. (NASDAQ:AAPL) launched the iPod in 2002, selling 400,000 units that year. Sales in 2003 were 900,000 followed by 4.5m in 2004 and 22m units in 2005
Analysts were slow to catch onto the new product momentum as evident from the earnings surprise chart, providing significant outperformance for Apple stockholders in 2003, 2004 and 2005
We identified Apple Inc. (NASDAQ:AAPL) as an attractive stock due to positive earnings revisions and improving price momentum in 2004
See full Lacy H. Hunt Presentation On Behavioral Finance: Identifying and Exploiting Emotion Driven Market Anomalies in PDF format here.
Behavioral Finance: Identifying and Exploiting Emotion Driven Market Anomalies
Full Josh Chisari Presentation On Behavioral Finance: Identifying and Exploiting Emotion Driven Market Anomalies via CFA Institute
