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Tuesday 27 July 2010

A Brief History of Behavioural Finance

The Nobel Prize for Psychology

Noble Prize winning committees aren’t renowned for consistency. Giving Barack Obama the Peace Prize for not being George W. Bush is a triumph of hope, but hardly based on rational analysis. We might also wonder if the selection panel got its wires crossed when it awarded the Economics prize to a psychologist.

But it wasn’t just any old shrink who got the bauble. It was Daniel Kahneman, half of the dynamic duo that invented the whole topic of behavioural finance. The other half, Amos Tversky, died in 1996. Between them, Tversky and Kahneman pump primed a change in the way we expect stocks to behave. Outside credit rating agencies, it’s no longer enough to assume we can predict market movements on the basis of number crunching on a grand scale. Now we need to take our own mental confusion into account.

Read full article at Monevator >>

1 comment:

  1. Investors, meanwhile, should avoid wasting their money on hopeless explanations of future market movements.

    This is the point at which we always part company, Tim.

    I certainly agree that we fooled ourselves with the Efficient Market Theory and Buy-and-Hold (which is rooted in a belief in the EMT). And I certainly agree that we might be fooling ourselves with Behavioral Finance too. The risk is there that there are flaws that we cannot see today.

    But we have to do something with our money! There is no neutral ground!

    An investor can go with EMT or he can go with BF or he can make something new up himself. Any model for understanding how stock investing works is going to contain some sort of explanation of how markets work. There's just no getting around this.

    If we really were to invest with zero expectations of what future returns are going to be, we would be engaging in pure gambling. That's a step up?