Richard Peterson discusses a new study that examines which parts of the brain are involved in irrational investment choices, which Peterson attributes to greed and fear, based on the areas of the brain active when the decisions were made. It's hard to agree that the students were experiencing actual fear, given the small stakes (an apparent $25 max payoff/loss) presented to the guinea pigs of the study, until you realize they were (probably starving) grad students locked in an MRI machine knowing their professors are watching their trading ability.
Perhaps this is the reason for the poor timing ability of mutual fund investors, and the apparent lack of alpha, at least in mutual funds:
Poor timing correlates positively with fund alpha (excess risk-adjusted return), to such an extent that the poor timing cancels the alpha even among the best-performing funds.
Peterson also discusses sunshine and the stock market:
The magnitude of the sunshine effect is substantial. For example, in New York City, the annualized nominal market return on perfectly sunny days is approximately 24.8% per year versus 8.7% per year on perfectly cloudy days.
Can brain damage make a better trader? Or is it simply emotions?
Researchers in a new paper reject investor herding, but find evidence of contrarian behavior.
Quant Investor discusses the strangely consistent price trend of MNCS.OB, which he attributes in part to "group mania." Update: The stock blows up a few days later.
Do mutual funds that practice behavioral finance outperform? Short answer: yes based on raw returns; no, based on risk adjusted returns, but interestingly they attract capital at a greater rate and act like value funds.
From James Montier, The Seven Sins of Fund Management:
How can behavioural finance inform the investment process? We have taken a hypothetical 'typical' large fund management house and analysed their process. This collection of notes tries to explore some of the areas in which understanding psychology could radically alter the way they structure their businesses. The results may challenge some of your most deeply held beliefs.
Among the sins: they overtrade, they try to absorb too much information, they rely on forecasts, and they have a short term focus.
Update:
This paper discusses "Investor Sentiment in Japanese and U.S. Daily Mutual Fund Flows"
In "Disposition Matters: Volume, Volatility and Price Impact of a Behavioral Bias:"
To do this, we use a large sample of individual accounts over a six-year period in the 1990's in order to identify investors who are subject to the disposition effect. We then use their trading behavior to construct behavioral factors. We show that when the fraction of "irrational" investor purchases in a stock increases, the unexplained portion of the market price of the stock decreases.
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