ISM Lecture 3 Topic 2 WebCT
INVESTMENT AND SECURITIES
MARKETS
Semester 1, 2010 / 2011
Ms. Viet Cao
Topic 2 – Formal overview of investor psychology
Part 1: Heuristic – driven biases
2010
Investment & Securities Markets
2
What are heuristics ?
– Trial and error rules of thumb or “mental shortcuts” to simplify complex judgment or decisions
– Includes intuitive “back-of-the-envelope” mental calculations
– However, heuristics are imperfect and often leads to errors
– Investors, like everyone else, commit decision errors as a result
– Behavioral psychology identifies the principles underlying these rules of thumb and the systematic errors associated with them
2010
Investment & Securities Markets
3
Representative heuristic
Questions
– Linda is a quiet girl who are concerned with social issues. She did a degree in English literature and environmental studies. Given this information, which of the following three cases is most probable?
• Linda is a librarian
• Linda is a librarian and active in environmental movement
• Linda works in the banking industry
– Peter is a streetwise extrovert who talks quickly and wears smart clothes. Young, bright and dynamic, he has a slight East London accent. He works for a large investment bank. What is the probability Peter is a derivatives trader?
2010
Investment & Securities Markets
4
Representative heuristic
Concept
– Judgments based on stereotypes
– How representative of, or similar to, the underlying category or process is the predicted event?
– Other factors that affect such judgments are frequently ignored
2010
Investment & Securities Markets
5
Representative heuristic
Illustrations
– Stock market reaction to dot.com firm name changes
• During the mania
• After the mania
– Fund style name changes and impact on fund inflows
– “Good firm good stock” syndrome
–
The use of the PEG in stock valuation
– The trustee fund manager selection interview
– Evaluating fund manager performance
2010
Investment & Securities Markets
6
MARKETS
Semester 1, 2010 / 2011
Ms. Viet Cao
Topic 2 – Formal overview of investor psychology
Part 1: Heuristic – driven biases
2010
Investment & Securities Markets
2
What are heuristics ?
– Trial and error rules of thumb or “mental shortcuts” to simplify complex judgment or decisions
– Includes intuitive “back-of-the-envelope” mental calculations
– However, heuristics are imperfect and often leads to errors
– Investors, like everyone else, commit decision errors as a result
– Behavioral psychology identifies the principles underlying these rules of thumb and the systematic errors associated with them
2010
Investment & Securities Markets
3
Representative heuristic
Questions
– Linda is a quiet girl who are concerned with social issues. She did a degree in English literature and environmental studies. Given this information, which of the following three cases is most probable?
• Linda is a librarian
• Linda is a librarian and active in environmental movement
• Linda works in the banking industry
– Peter is a streetwise extrovert who talks quickly and wears smart clothes. Young, bright and dynamic, he has a slight East London accent. He works for a large investment bank. What is the probability Peter is a derivatives trader?
2010
Investment & Securities Markets
4
Representative heuristic
Concept
– Judgments based on stereotypes
– How representative of, or similar to, the underlying category or process is the predicted event?
– Other factors that affect such judgments are frequently ignored
2010
Investment & Securities Markets
5
Representative heuristic
Illustrations
– Stock market reaction to dot.com firm name changes
• During the mania
• After the mania
– Fund style name changes and impact on fund inflows
– “Good firm good stock” syndrome
–
The use of the PEG in stock valuation
– The trustee fund manager selection interview
– Evaluating fund manager performance
2010
Investment & Securities Markets
6
References: Shefrin, 2007, Behavioral Corporate Finance, chs 1, 2 and 3 Shefrin, ch.7 p Hersh Shefrin, Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, Oxford University Press, 2002, ISBN 0-19-516121-1 Hersch Shefrin, Behavioral Corporate Finance, McGraw-Hill, 2007, ISBN 0-07-284865-0 2010