Behavioural Finance - Market Impact and Investment Applications

2 days
Prague, NH Hotel Prague
  • Efficient vs. Inefficient Markets – Fama vs. Shiller
  • Prospect Theory, Frame Dependence and Biases
  • Inefficient Markets and Securities Pricing
  • A New Paradigm of Practical Application of Behavioural Finance
  • Creating a Successful Advisory Relationship with Behavioural Finance
  • Emotions, Aspirations and Goals-Based Investing
  • Integrating Traditional and Behavioural Finance
  • Portfolios, Pyramids, Emotions, and Biases
  • A Behavioural Approach to Portfolio Optimization
The purpose of this seminar is to give you a good understanding of the psychological factors that affect investment decision making of investors and to discuss how these factors affect financial markets and how they can be successfully integrated into the investment management process.

We start with the important discussion about efficient vs. inefficient markets, reflecting upon the views of the two Nobel laureates, Eugene Fama and Robert Shiller. We the take a closer look at behavioral finance and its applications. We explain what behavioral finance is and, using examples from financial crises, we discuss how investor psychology may lead to a "herd" behavior that exacerbates swings, bubbles and crashes in financial markets. We also discuss how behavioral finance can help the investment manager in creating a successful relationship with the client.

We then explore in-depth the various themes of behavioural finance. The first theme is frame dependence. We here explain how loss aversion can result in investors' willingness to hold on to deteriorating investment positions and we evaluate the impacts that the emotional frames of "self-control", "regret minimization", and "money illusion" have on investor behaviour. The second theme is heuristic-driven biases. We explain how biases such as "representativeness", "overconfidence", "anchoring-and-adjustment", "availability bias" and "aversion to ambiguity" can impact long-term and short term forecasts and lead to inconsistent investment decisions and outright investment mistakes.

Further, we evaluate the impact that representativeness, conservatism, frame dependence, and overconfidence may have on security pricing and discuss the implications for market efficiency.

The main part of the course is focused on how to apply behavioural finance in an investment setting. We introduce the so-called "new paradigm" of practical application of behavioural finance and explain how behavioural finance theory is used in investor profiling. We also introduce the concept of "goals-based investing", and we explain how portfolios can be structured as layered pyramids and how such structures address needs associated with security, potential, and aspiration. We evaluate the effects of regret and self-attribution bias on the relationship that investors form with their investment managers, and we evaluate the impact of excessive optimism and overconfidence on investors' decisions regarding portfolio construction. We also explain and demonstrate how an investor's "lifestyle objectives" can be translated into a quantitative risk budget and how an optimal portfolio can be constructed under this constraint. Finally, we discuss how biases and frame dependence may also affect investments decisions of institutional investors.

09.15 - 12.00 Introduction to Behavioural Finance

  • Behavioural Finance vs. Traditional Finance
  • Nobel Laureates: Fama vs. Shiller
  • Herd Behavior, “Irrational Exuberance” Bubbles and Crashes
  • Overview of Market and Investment Implications and Opportunities
  • How BF Can Help You Creating a Successful Advisory Relationship

Main Themes in Behavioural Finance

  • Prospect Theory
  • Frame Dependence
    • Concurrent decisions and mental accounting
    • Hedonic editing
    • The “House Money” effect
    • Loss aversion
  • Biases
    • Representativeness bias - “gamblers fallacy”
    • Overconfidence bias
    • Anchoring-and-adjustment bias, conservatism bias
    • Self-control bias
    • Fear of regret and regret minimization
    • The theory of cognitive dissonance
  • Case Studies
    • How frame dependence and cognitive and mental biases may lead to inconsistent investments and (dangerous) investment mistakes
  • Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Behavioural Finance and Inefficient Markets

  • “Efficient” vs. “Inefficient” Markets
  • Is the “Efficient markets Hypothesis” the Biggest Mistake in Financial History?
  • The Impact of Representativeness, Conservatism, Frame Dependence, and Overconfidence on Security Pricing
  • Implications for Market Efficiency
  • The Folly of Forecasting
    • How the illusions of knowledge and control lead expert forecasters to be overconfident in their forecasting skills
    • Ego defense mechanisms and inaccurate forecasts
    • Why forecasts may continue to be used when previous forecasts have been inaccurate
  • Acute and Chronic Market Inefficiencies
  • Portfolio Rebalancing Behaviour
    • Holders, rebalancers, valuators, and shifters
    • The impact of rebalancing behaviours on market efficiency
  • Practical Applications
    • How Market Inefficiencies Can Be Exploited in Investing and Trading Strategies
  • Small Exercise

Day Two

09.00 - 09.15 Brief recap

09.15 - 12.00 Practical Application of Behavioural Management in Portfolio Management

  • New Paradigm of Practical Application of Behavioural Finance
    • How behavioural finance can help you in creating investment programs based on personality type and gender to produce better investment outcomes
  • Client Profiling
    • Psychographic models used in BF
    • “Passive” vs. Active investors (Barnewall two-way model)
    • Bailard, Biehl and Kaiser five-way model
    • Using questionnaires to determine a clients’ risk tolerance
    • Correlating behavioural finance biases with psychographic measures
    • Statistical testing to identify and measure biases
    • Gender-based bias testing
    • Myers-Briggs type indicator and behavioural bias testing
  • Understanding How Frame Dependence and Biases Could Destroy Value
    • Insufficient/naïve diversification
    • Excessive trading
    • The disposition effect
  • How to Handle Irrational Client Preferences
    • Moderate or adapt?
  • Preparing of an Investment Policy Statement that Reflects Investor’s Personality
    • Formulating risk and return objectives in terms of aspirations and lifestyle objectives
    • Formulating constraints based upon unique preferences
  • Case Study and Exercise

12.00 - 13.00 Lunch

13.00 - 16.30 Practical Application of Behavioural Management in Portfolio Management (Continued)

  • Goals-Based Investing
    • Integrating traditional and behavioural finance
    • Assessing objective-related risk
    • Converting life-style objectives to a risk-budget
  • Portfolios, Pyramids, Emotions, and Biases
    • The influence of hope and fear on investors’ desire for security and investment potential
    • How portfolios can be structured as layered pyramids
    • How structures address needs associated with security, potential, and aspiration;
    • The effects of regret and self-attribution bias on the relationship that investors form with their financial advisers
  • Practical Case Study
    • Portfolio optimization under future spending shortfall constraint
  • Investment Decision Making in Pension Funds and Insurance Companies
  • Case Studies and Small Exercises

Summary, Evaluation and Termination of the Seminar

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