Behavioral Finance - Investors’ Psychology, Market Impact and Investment Applications

• Fear, Greed, Bubbles and Market Crashes
• Heuristic-Driven Biases and Frame Dependence
• Inefficient Markets and Securities Pricing
• Creating a Successful Advisory Relationship with Behavioral Finance
• Integrating Traditional and Behavioral Finance
• Goals-Based Investing
• Portfolios, Pyramids, Emotions and Biases
• Investment Strategies for Inefficient Markets

The objective of this seminar is to give you a good understanding of the psychological factors that affect investment decision making of investors and to discuss how these factors affect financial markets and how they can be integrated into the investment planning process.

We start with an overall introduction to behavioral finance and its applications. We explain what behavioral finance is and, using examples from financial crises, we discuss how investor psychology may lead to a “herd” behavior that exacerbates swings, bubbles and crashes in financial markets. We also discuss how behavioral finance can help the investment advisor in creating a successful advisory relationship.

We then explore in-depth the various themes of behavioral finance. The first theme is heuristic-driven biases. We explain how biases such as “representativeness”, “overconfidence”, “anchoring-and-adjustment”, “availability bias” and “aversion to ambiguity” can impact long-term and short term forecasts.

The second theme is frame dependence. We here explain how loss aversion can result in investors’ willingness to hold on to deteriorating investment positions and we evaluate the impacts that the emotional frames of “self-control”, “regret minimization”, and “money illusion” have on investor behavior.

Further, we evaluate the impact that representativeness, conservatism, frame dependence, and overconfidence may have on security pricing and discuss the implications for market efficiency.

Finally, we discuss how behavioral finance can be used in the investment management process. We introduce the concept of “goals-based investing” and explain how portfolios can be structured as layered pyramids and how such structures address needs associated with security, potential, and aspiration. We evaluate the effects of regret and self-attribution bias on the relationship that investors form with their financial advisers, and we evaluate the impact of excessive optimism and overconfidence on investors’ decisions regarding portfolio construction. We also explain and demonstrate how a client’s “lifestyle objectives” can be translated into a quantitative risk budget and how an optimal portfolio can be constructed under this constraint.

 

Day One

09.00 - 09.15 Welcome and Introduction

09.15 - 12.00 Introduction to Behavioral Finance

• Behavioral Finance vs. Traditional Finance
• Herd Behavior, “Irrational Exuberance” Bubbles and Crashes
• Overview of Market and Investment Implications and Opportunities
• How BF Can Help You Creating a Successful Advisory Relationship
• Using Behavioral Finance in Client Profiling
  • Psychographic Models Used in BF
  • “Passive” vs. active investors (Barnewall two-way model)
  • Bailard, Biehl and Kaiser Five-Way Model

Heuristic Biases

• Representativeness
  • How long-term earnings forecasts tend to be biased in the direction of recent success
  • “Gamblers fallacy”
• Overconfidence
• Anchoring-and-Adjustment
  • Why estimates are not revised enough to reflect new information
• Aversion to Ambiguity
• Case Studies and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Frame Dependence

• Transparent vs. Opaque Frames
• Concurrent Decisions and Mental Accounting
• Decision Problems as Packages
• Hedonic Editing
• Cognitive and Emotional Aspects
• The “House Money Effect”
• Loss Aversion
  • how loss aversion can result in investors’ willingness to hold on to deteriorating investment positions
• Self-Control
• Fear of Regret and Regret Minimization
• Money Illusion
  • the impacts that the emotional frames of self-control, regret minimization, and money illusion have on investor behavior
• Case Studies and Small Exercises

Day Two

09.00 - 09.15 Recap

09.15 - 12.00 Inefficient Markets

• “Efficient” vs. “Inefficient” Markets
• Is the “Efficient markets Hypothesis” the Biggest Mistake in Financial History?
• The Impact of Representativeness, Conservatism, Frame Dependence, and Overconfidence on Security Pricing
• Implications for Market Efficiency
• The Folly of Forecasting
  • How the illusions of knowledge and control lead expert forecasters to be overconfident in their forecasting skills
  • Ego defense mechanisms and inaccurate forecasts
  • Why forecasts may continue to be used when previous forecasts have been inaccurate
• Acute and Chronic Market Inefficiencies
  • Behavioral factors that may give rise to chronic inefficiencies
• Portfolio Rebalancing Behavior
  • Holders, rebalancers, valuators and shifters
  • The impact of rebalancing behaviors on market efficiency
• Case Studies and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Investment Applications and Strategies for Inefficient Markets

• Portfolios, Pyramids, Emotions, and Biases
  • The influence of hope and fear on investors’ desire for security and investment potential
  • How portfolios can be structured as layered pyramids
  • How structures address needs associated with security, potential, and aspiration;
  • The effects of regret and self-attribution bias on the relationship that investors form with their financial advisers;
  • The impact of excessive optimism and overconfidence on investors’ decisions regarding portfolio construction.
• Incorporating Investor Behavior into the Asset Allocation Process
  • Integrating traditional and behavioral finance
  • Converting life-style objectives to a risk-budget
• Investment Decision Making in Pension Funds and Insurance Companies
• How Market Inefficiencies Can Be Exploited in Investing and Trading Strategies
• Case Studies and Small Exercises

Evaluation and Termination of the Seminar