Behavior and Psychology of Finance
Wednesday, May 16, 2007
Presented by the Quantitative Finance discussion group
Endorsed by the International Association of Financial Engineers (IAFE)
Please join us to learn about how research on human and social cognitive and emotional biases is being used to better understand the markets. A panel discussion will follow the talks which will include two industry representatives.
This is the second symposium on Quantitative Finance at The New York Academy of Sciences as part of a new initiative launched in physical sciences and engineering. Given the Academy's new location at 7 World Trade Center and the number of scientists who work in finance, the goal of this symposium is to build community by creating collaborations and developing professional networks between the science and finance communities.
Moderator: Emanuel Derman, Columbia University & Prisma Capital Partners
5:00 pm: Terrance Odean, University of California, Berkeley
5:30 pm: Steve Ross, MIT
6:00 pm: Panel Discussion
Rick Bookstaber, FrontPoint Partners
Dave Fields, AIG
Terrance Odean, University of California, Berkeley
Steve Ross, MIT
Q & A
Terrance Odean, PhD
Univeristy of California, Berkeley
Systematic biases in the trading behavior of investors can create pressure that drives prices away from fundamental values. Costs and risk limit the ability of would be arbitrageurs to take advantage of, and thereby reduce, mispricing. Analyzing the trading records of hundreds of thousands of individual and institutional investors, We find that individual investors tend to trade too frequently, hold onto their losing investments, and buy stocks that are in the news. Psychological motivations for these behaviors are overconfidence, a desire to avoid feeling regret, and the limits of human attention. Investors, especially those who have experienced recent success, are likely to be overconfident about their abilities. Overconfidence leads to excessive trading and lower returns. The stocks that individual investors buy tend to subsequently underperform those they sell. Active investors tend to underperform buy-and-hold investors and investors who switch to online trading tend to trade more actively, more speculatively, and less successfully after going online. Investors tend to buy stocks that are in the news, irrespective of whether the news is good or bad. These trading behaviors lead to substantial reductions in portfolio returns for individual investors. Furthermore, the trading of individual investors forecasts future asset returns.
Steve Ross, PhD
Massachussetts Institute of Technology
Behavioral finance has become the catch phrase for a host of empirical anomalies in the financial markets. For the behavioral school, market inefficiencies are rampant and its no wonder because investors determine prices and investors are thoroughly irrational, ruled by their emotions, cannot figure out what is in their own best interest, and behave like stampeding cattle. Is the bell is tolling for the efficient market neoclassical view of finance and are we witnessing the start of a quantum like revolution that brings psychology to the fore. This talk takes the position that, like Twain, rumors of the death of neoclassical finance are greatly exaggerated, and that the new emperor may need to visit a clothing store.
Richard Bookstaber is the portfolio manager for a quantitative equity hedge fund at FrontPoint Partners in Greenwich, Connecticut. He came to FrontPoint from Ziff Brothers Investments, where he was the managing director responsible for risk management and where he developed and managed the firm's quantitative long/short equity portfolio. Before joining Ziff in 2002 he was responsible for risk management