You are currently browsing posts tagged with decision making
This week was made interesting by the US financial markets and Chapter 11. And if all the bad news wasn’t enough Google and Chicago Tribune made it more happening by letting everyone think that United Airlines had filed for bankruptcy too to cut costs.
I will let Chicago Tribune give you the story in detail, that sort of fits anyway. Just to give you a gist
The steep sell-off in United’s shares came after a news service in Florida distributed an old story posted on the South Florida Sun-Sentinel Web site six years ago. Monday’s recirculated story gave the appearance that United had filed for bankruptcy protection again. In fact, the story was originally published Dec. 10, 2002, by the Chicago Tribune, marking the airline’s decision at that time to seek protection from creditors.
And more importantly for us, moments after a headline for the story hit Bloomberg, shares in United stock fell from about $12 a share to a low of $3, prompting a halt in trading of United stock.
Of course, once the truth was out the stock got back to a slightly lower $10 odd and will probably now reach its market value of $12 and might start trading in a regular manner.
What Happened Here?
What we saw was a perfect simulation of Panic Selling and to a certain extent noise trading. I intend to cover these two in details later (so watch this space for that).
§ Read the rest of this entry…
If you found this post useful click here to subscribe to future updates!
Considering the fact that I haven’t blogged here in over 2 weeks, I thought let’s keep the theory a little away today and dig into the evolution of behavioral finance to what it is these days. Hopefully, I have done justice to it, but with over a 100 years of history it wasn’t really easy.
Though research and development of financial models based on behavioural finance started very recently the idea of behavioural finance is not new. Many investors have long considered that psychology plays a key role in determining the behaviour of markets. However it is only in the past couple of decades that a series of concerted formal studies have been undertaken in this area. Paul Slovic’s (1972) paper on individual’s misperceptions about risk and Amos Tversky and Daniel Kahneman’s papers on heuristic driven decision biases and decision frames (1979) being some of the major works in the field. The results of these studies were significantly different from the rational, self-interested decision-maker that by traditional finance models explained.
Yet as said before, Most of the ideas in behavioural economics are not new and actually they return to the roots of neoclassical economics.
When economics first became identified as a distinct field of study, psychology did not exist as a discipline. Many economists moonlighted as the psychologists of their times. Adam Smith, who is best known for the concept of the “invisible hand” and The Wealth of Nations, wrote a less well-known book The Theory of Moral Sentiments, which laid out psychological principles of individual behaviour that are arguably as profound as his economic observations.
§ Read the rest of this entry…
If you found this post useful click here to subscribe to future updates!
§ August 24th, 2008 § Filed under Concepts
The term quasi-magical thinking, as defined by Shafir and Tversky (1992), is used to describe situations in which people act as if they erroneously believe that their actions can influence an outcome (as with magical thinking) but in which they in fact do not believe this. It includes acting as if one thinks that one can take actions that will, in effect, undo what is obviously predetermined, or that one can change history.
In investing, quasi magical thinking can be felt or seen in the way investors sometimes decide to buy or sell stocks. They may do a certain action before making a purchase, take God’s name before making any transaction, wear their left socks first, though they do realize that they do this for their own satisfaction and it does not bear any effect i.e. information-wise in the result of the trade. They do it with the belief that such an action can correct any mistake or help them in not making a mistake, though it seldom happens that way.
§ Read the rest of this entry…
If you found this post useful click here to subscribe to future updates!
§ August 16th, 2008 § Filed under Concepts
In the psychological literature there is no precise definition of overconfidence. There are several findings that are often summarized as overconfidence. Under this view, which is the broadest possible that can be found in the literature, overconfidence can manifest itself in the following forms: miscalibration, the better than average effect, illusion of control, and unrealistic optimism. As an investor you might find yourself in such situations often and perhaps not realize that you are showing signs of overconfidence while making investment decisions. The trick is to realize it or to see it in others to make the most of an investment opportunity.
§ Read the rest of this entry…
If you found this post useful click here to subscribe to future updates!
Economists believe the perception of risk to be the most important factor in investor decision making. Investing decisions are always taken on the basis or the amount of risk involved in the investment. I.e. two people when given the same amount of money needn’t necessarily invest in the same manner. The reason is the perception of risk and the need of the investor. What can be percieved as a huge risk by someone may be the minimum risk involved as perceived by someone else. And some might be willing to bear the effects of the risk involved, while some may not.
Thus practitioners of behavioural finance and finance advisors need to understand the level or the risk perception that their client carry in their mind and need to design investment methods on the same basis. Hence, an understanding of risk and its characteristics is an integral part of behavioural finance.
§ Read the rest of this entry…
If you found this post useful click here to subscribe to future updates!