? Profiting from Irrationality Behavioral Finance in the Philippines Francisco L. Roman Jr., DBA 1 /45 Table of Contents I. “ Is Behavioral Finance a Growth Industry? ” What is Behavioral Finance? Behavioral AND Traditional Finance Examples of Terms
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Profiting from Irrationality
Behavioral Finance in the Philippines
Francisco L. Roman Jr., DBA
Behavioral AND Traditional 1/2
The idea is simple: Investors are not as rational as traditional theory has assumed, and so biases in their decision-making can have a cumulative effect on asset prices.
In efficient market theory, assets are correctly priced because supply and demand reflect aggregate public knowledge about those assets, and that the movement of stock prices can not be reliably predicted based on past results.
Traditional AND Behavioral 2/2
Two Points of View
Behavioral Finance models will NOT
replace the theory of
The idea that investors and managers are NOT uniformly rational makes intuitive sense.
Basic Market “Psychology”:
Buy out of Greed. Sell out of Fear.
Behavioral Finance goes Beyond Greed and Fear.
The “Traditionalists” Critique
Behaviorial Finance Response
In finance, you are playing against people, who value assets on the basis of their expectations about the future. These expectations are ephemeral, or at best unstable.
Efficient market models of rational behavior are not BAD descriptions of reality. They’re just NOT going to capture everything. Since bubbles and other anomalies have real economic effects, and occur often enough, it is worth devoting time and effort trying to understand what drives them and whether their impact can be contained.
From the Traditionalists:
There’s a big demand for behavioral finance among the practitioners because nobody wants to believe the markets are efficient, but if there’s so much money on the table, how is it that professional managers can’t do any better than index funds?
From the Behaviorists:
BF doesn’t say “There’s easy money. Go after it.” It says that psychology causes market prices and fundamental values to part company for a long time.
Potential profit opportunities come packaged together with additional risk, and “smart money” can’t or won’t take a large enough bet to eradicate the anomalies, and won’t be able to arbitrage away the anomalies and return the market to equilibrium.
Examples of Terms 1/3
= “Rules of Thumb” = “Biases”
* Disposition Effect
* Herd Mentality
* Regret Minimization
Examples of Terms 2/3
Examples of Terms 3/3
Findings From DC Markets1/4
Just as an investor can can set a floor for the price of a security by buying a put option, so Mr. Greenspan will provide a floor for the stock market by cutting interest rates when it gets too low for his liking.
Findings From DC Markets 2/4
One weakness of the efficient market theory is the assumption that arbitrage by the informed (rational investor) against the uninformed (e.g., biased) is riskless and costless.
Assume a relatively small volume of shares in circulation that can not meet the demand by would-be shorters. Peoples with imperfect valuations can set prices that are out of line.
Findings From DC Markets 3/4
Findings From DC Markets 4/4
Findings From LDC Markets 1/2
Findings From LDC Markets 1/2
The FINEX Survey
> “Rules of Thumb” = “Biases”
> Disposition Effect
> Herd Mentality
> Regret Minimization
Sell winners early
Case Examples 1/2
Case Examples 2/2
Survey Sample 1/3
Survey Sample 2/3
Survey Sample 3/3
On the Two Paradigms 1/2
On the Two Paradigms 2/2
Investors combine both paradigms.
Disposition Effect 1/4
Disposition Effect 2/4
Meantime, do you make other investments?
Once in a while
Disposition Effect 3/4
Disposition Effect 4/4
Investors “respond” to paper losses/gains.
Floor: Hold losers up to a 20% decline.
Ceiling: Sell winners after a 20% rise.
While waiting, will NOT buy the same stock.
Instead, buy OTHER stock or asset.
Analysts’ Rate Themselves 1/2
Analysts’ Rate Themselves 2/2
Let the Viewer decide.
Non-CFOs Rate Analysts
When they’re right, they deliver.
Herd Mentality, Representativeness & Regret Minimization 1/6
Herd Mentality, Regret Minimization
& Representativeness 1/6
Herd et al. 2/6: Reasons for
Herd et al. 3/6: Reasons for
Herd et al. 4/6: Reasons for
Herd et al. 5/6: Reasons for
Herd et al. 6/6: Reasons for
Some Herd et al.
Some Bad Calls
For the Retail Investors
Research does show that these people tend to hold on to a losing investment and to sell a winning investment too quickly relative to their opportunity costs.
Retail investors who think they’re clever enough to beat the market probably don’t even understand traditional finance ideas and should simply follow a passive long-term strategy.
Aquino Ramos Estrada Arroyo
Still at Basics 16 3 7 4
Moving Up 13142011
Excellent 1 4 1 1
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