Saturday, 12 December 2009

Behavioural finance working group: part 1

The lack of postings in recent days has been partly due to attending a conference: "Behavioural perspectives on the financial crisis" at Cass Business School (no relation to Cass Sunstein).

It turned out not to be quite as billed. An interesting selection of short research presentations but barely any mention of the crisis at all.

Highlights of the first day included:

Addressing the psychology of financial markets: a good qualitative insight from David Tuckett, a psychologist from UCL, into the psychological factors which affect finance. He identified a very intriguing difference between finance markets and other markets: which I'd express as saying that finance markets have no referent. Other markets involve real assets which are traded, and which provide real and direct utility. Financial markets provide no direct utility feedback from a purchase - investors hold an asset whose only utility is from its (unpredictable) future value. Thus emotional factors take the place of real ones in how we relate to the market. This can disrupt the diminishing returns dynamic which helps establish stable equilibria; instead, it creates reflexivity, self-fulfilling prophesies and volatility.

Stories matter: the Effect of News in a Laboratory Asset Market: by Sudeep Ghosh from Hong Kong Polytechnic University. This research measured the difference between providing investors with facts, and providing them with stories that explain the facts. It turns out that stories affect behaviour more than facts do; and bid-ask spreads are higher when investors receive stories. Interestingly the stories were designed (as far as possible) to contain no additional information, but simply a narrative structure to make the facts somehow more understandable. The cognitive factors behind this are not clear, but it's certainly an interesting area to explore.

A very energetic and charming presentation from Steven Jordan about the international evidence for long-term reversals. Not my area at all, but an honourable mention for being funny, hyperactive and managing to go through his material at twice the speed of anyone else yet still running out of time.

And finally the keynote speech from Werner de Bondt: Investor sentiment and financial stability. A good survey of the crisis from a behavioural point of view. I felt he didn't quite demonstrate convincingly that psychology was at the source of the crisis, though he gave lots of good illustrations and is a highly articulate presenter. Very similar in style to Richard Thaler - with whom he has worked closely for the last thirty years, so perhaps not too surprising. He has a plausible descriptive model of bubbles: that they originate in psychology and become inflated through short-term rational mechanisms, then become subject to herd behaviour before bursting at some unpredictable point.

I'll post more shortly about the second day of the conference and link to my notes on the various talks.

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