Hi all! I’ve posted some helpful links to go with the behavioral economics/finance BQF presentation. In addition, you can see an animated version of the slides below. Before we get to that, however, I wanted to follow up with a more detailed answer to a common question from the event.
Obviously, given the nature of the event, attendees (rightfully) put a high priority on the “actionability” or “investibility” of all of the information that they are given. In my view, one of the key prerequisites for designing successful investment strategies (arbitrage or otherwise) is to understand as much as possible about the markets that one is investing in. This process is initially mostly descriptive in nature, but to do otherwise would be putting the cart before the horse. After an anomaly or irrationality (read, potential opportunity) has been identified, the next step is to try to understand why it’s happening in the market. Due to the nature of their business, this is generally where academics stop, and I am not going to even come close to claiming to give investment advice (though people like to ask all the time because they think that that is what economists do).
From an investment perspective, therefore, the next step is to identify why an opportunity isn’t getting arbitraged (or at least invested) away and then to consider whether you or your firm is in a position to take advantage of opportunities that others can’t. These advantages could be due to differences in institutional or other restrictions on investing (not being able to short a closed-end fund, for example), differences in information processing capabilities (or different information, for that matter), differences in investor time horizons (i.e. lock-up periods), differences in borrowing rates, and so on. As a result, there may be cases where you can creatively design alpha-generating strategies where others can’t and thus reap the benefits of your behavioral finance knowledge. On the flip side, if you understand why certain market anomalies aren’t getting arbitraged away, you can avoid getting into positions that are not sustainable for your firm. (LTCM, I’m talking to you.) Nonetheless, the quest for profit opportunities start (or, at least, should start) with an understanding of market imperfections and the reasons behind them. Otherwise, you’re just noticing patterns and hoping that the patterns continue (or reverse themselves, as the case may be), which we’ve been shown can be a risky endeavor.
Anyway, back to the slides…
(Note: To advance properly through the animation, just wait a few seconds for the pause button to turn back to a play button and click forward. If you are experiencing difficulties, you probably need to install the latest versions of Flash and Shockwave from Adobe.)
- More on the history of behavioral economics, with pictures
- For a rather detailed overview of prospect theory, see Prospect Theory: An Analysis of Decision Under Risk”
- See also “The Endowment Effect, Loss Aversion, and Status-Quo Bias” For an alternate explanation of the endowment effect, see “Bad riddance or good rubbish? Ownership and not loss aversion causes the endowment effect”
- Terrance Odean, “Are Investors Reluctant to Realize Their Losses?
- John List, “Does Market Experience Eliminate Market Anomalies?”
- Brigitte Madrian and Dennis Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior”
- Richard Thaler, “Mental Accounting Matters” (also see Daniel Read, George Loewenstein, and Matthew Rabin, “Choice Bracketing”)
- Jay Ritter, “Behavioral Finance” (not mentioned in the talk but a good overview of the subject)
- Jeremy Siegel and Richard Thaler, “Anomalies: The Equity Premium Puzzle”
- Shlomo Benartzi and Richard Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle
- J. Bradford DeLong and Konstantin Marin, “The U.S. Equity Return Premium: Past, Present, and Future”
- Owen Lamont and Richard Thaler, ‘Anomalies: The Law of One Price in Financial Markets”
- Charles Lee, Andrei Shleifer, and Richard Thaler, “Anomalies: Closed-End Mutual Funds”
- Warner De Bondt and Richard Thaler, “Anomalies: A Mean-Reverting Walk Down Wall Street”
- Richard Thaler, “Anomalies: The January Effect”
- Richard Thaler, “Seasonal Movements in Security Prices II: Weekend, Holiday, Turn of the Month, and Intraday Effects”
- Choices, Values, and Frames
- Inefficient Markets: An Introduction to Behavioral Finance
- Advances in Behavioral Economics
- Advances in Behavioral Finance
- The Winner’s Curse: Paradoxes and Anomalies of Economic Life (Note: This volume contains a general-reader treatment of Thaler’s “Anomalies” papers listed above.)
- Thinking, Fast and Slow
- Nudge: Improving Decisions About Health, Wealth, and Happiness
- Predictably Irrational: The Hidden Forces That Shape Our Decisions
I hope this is helpful, and feel free to send follow up questions my way at econgirl at economistsdoitwithmodels dot com.