minds and markets: some frontiers of behavioral finance...•prospect theory: –hate to lose...
TRANSCRIPT
BeFi Web Seminar for May 30, 2007
Minds and markets: Some frontiers of behavioral finance
by Colin CamererCaltech
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Minds and markets:Some frontiers of behavioral finance
Colin Camerer, [email protected]
• See opportunities others don’t see– Psychology: Attention + curiosity
• Understand the fears and hopes of investors– Psychology: Prospect theory– Neuroscience: Fear of the economic unknown
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1. See opportunities others don’t see
• Conscious attention is limited– “Flicker” paradigm– Top-down encoding: “I’ll believe it when I see it”
• Visual and cognitive illusions
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How many F’s are there?
FINISHED FILES ARE THE RE-SULT OF YEARS OF SCIENTIF-IC STUDY COMBINED WITHTHE EXPERIENCE OF YEARS
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How many F’s are there?Answer: 6!
FINISHED FILES ARE THE RE-SULT OF YEARS OF SCIENTIF-IC STUDY COMBINED WITHTHE EXPERIENCE OF YEARS
• The brain ‘sees sounds’ andautomatically encodes “of” as “ov”
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How far can attention go?
• Attention can bestretched butmemory suffers
• E.g. “I Love Lucy”chocolate factoryepisode
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Do markets have ADD?• A. Earnings announcements
– Friday reaction is slower• B. Distant demographic effects are underpriced
– Bicycles and drugs• C. Attention-grabbing events drive volume
– Barber-Odean• D. ENMD (reading the market’s reading)
– Nature vs New York Times• E. Paying attention makes you smarter: Curiosity
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A. Earning reports:(dark blue) Fridays react more slowly
(Della Vigna-Pollet 06)
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B. Demographic profiles forbicycles (red) & drugs (blue): Investors
look only 5 (…years!) ahead
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C. Attention-grabbing events volume
• High-volume or high-volatility stocks get20% more individual investor trade (Barber-Odean 06)
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D. news (Nature) vs. NEWS (NYTimes)
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E: Paying attention makes you happyand smart(er):
Curiosity is the hunger pang of an info-vore
• Einstein: “I have no specialtalents. I am merelypassionately curious”
• The wick in the candleof learning
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Curiosity-piquing question
• What animal excrement is eaten as adelicacy?
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Curiosity-piquing question
• What animal excrement is eaten as adelicacy?
• A: Bat guano
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Curiosity activates reward areas…• “Striatum”
activated by:– Cocaine– Money– Expected
return– Faces of
cooperators– “warm glow”
charity– information…
when youare curious
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…and curiosity enhances memory:highly curious remember wrong
answers twice as often
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2. The fears and hopesof investors
• Prospect theory:– Hate to lose compared to a reference point– Overweight or ignore rare “black swan” events– Fama: “morbid fear of a recession”
• Preference for the familiar– “Home bias” (countries, Baby Bells, local firms)– Aversion to unfamiliar activates fear areas
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• Kahneman & Tversky (1979) most-cited empirical paper in economicspost-1970
Gains = x(ρ)
Losses = -λ*(-x)(ρ)
Prospect theory value FunctionA special role for losses
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Nonlinear weighting of probabiltiyin choices↓ and in the brain
↓
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Overweighting low probabilityis severe– a quantum of possibility?– π(p) =1/e(ln(1/p))α (α=1 linear)
– Typical measured value (α=.77)• π(.10)=.15 (x1.5)• π(.01)=.04 (x4)• π(.001)=.012 (x12)• π(.000001)=.000515 (x 515)
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(Tom et. al. 07 Sci) Increased gain/reduced lossactivates striatum…. brain (x) correlates
with behavior(y)
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Can investors be immunizedagainst loss-aversion? Maybe…
140 choices gamble vs. guaranteed
RiskyGamble
Guaranteed
p=0.5
p=0.5
Accept the gamble?
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Emotional down-regulation:Instructed to ‘think like a trader’…
One way to think of this instruction is to imagineyourself a trader. You take risks with money everyday, for a living. Imagine that this is your job, andthat the money at stake is not yours – it’s someoneelse’s. Of course, you still want to do well (your jobdepends on it). You’ve done this for a long time,though, and will continue to. All that matters is thatyou come out on top in the end – a loss here or therewon’t matter. In other words, you win some and youlose some.
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Down-regulation decreasesbiological response to actual loss
• Decreases skinconductance (not shown)
Decreases activity inright amygdala (cross-hair location)
217 voxelstmax= 72.78p < .006
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Down-regulation of loss-aversionlowers measured λ
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
0.6
INDIVIDUAL SUBJECTS
% D
EC
REA
SE I
N L
AM
BD
A
(λ”Attend” - λ”Regulate”) as percent of λ”Attend”
The down-regulation strategy decreasesloss aversion (t=5.40 p<.000003 N=45, Paired t-
test)
(caveat re: ρ)
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Fear of the economic unknown(e.g. home bias in investing)
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fMRI shows brain areas
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Activation when fearing theeconomic unknown
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In the news
April 20, 2006ECONOMIC SCENEEnter the Neuro-Economists: Why Do Investors DoWhat They Do?By TYLER COWEN
….A neuro-economics laboratory at CalTech, led by Colin F. Camerer…hasassembled the foremost group ofinterdisciplinary researchers….
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Conclusions & the future
• 1. Missing attention profits• 2. Fears and hopes of investors• Science fiction:
– Predicting bubble crashes from brain signals– Collective attention (herding…)– Measuring risk propensity neurally– Changing reactions to loss (down-regulation)– Identifying great traders, rogue traders, and
burnout.
P R E S E N T E D B Y
Shlomo BenartziCo-Founder, BeFiAssociate Professor Co-chair of theBehavioral Decision Making GroupThe Anderson School at UCLA
Warren CormierCo-Founder, BeFiPresident, Boston Research Group
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eFi F
orum
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