10 Years of Behavioral Finance: Thaler, Kahneman, Statman, and Beyond

mark Entrepreneurial investor’s 10th anniversary, we’ve compiled retrospectives of our coverage of the most critical topics in finance and investing over the past decade.

Much of the philosophical architecture of modern finance—modern portfolio theory (MPT), the capital asset pricing model (CAPM), the efficient market hypothesis (EMH), etc.—is based on the underlying rationality of the collective human inputs that drive market movements. . Markets are fundamentally efficient, conventional theory holds, and investors generally want to maximize returns for a given level of risk and will make investment decisions accordingly.

But over the decades, the work of Herbert Simon, Daniel Kahneman, Amos Tversky, Robert J. Shiller, and Richard H. Thaler, among others, challenged this orthodoxy and showed that market and investor behavior is often much more ambiguous than these theories would make it out to be. to suggest

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Whatever investors did, these researchers found, they didn’t follow the “rational model.” homo economicus expected by conventional finance.

Of course, Kahneman, Shiller and company were hardly preaching to an empty cathedral. Evidence of collective human biases and irrationality in finance was never particularly hard to find. But the Global Financial Crisis (GFC) and everything that has followed has further stimulated interest in behavioral finance.

It’s not hard to see why. In the shadow of the Great Recession, financial markets have presented too many anomalies, from negative interest rates to the GameStop fiasco, that conventional theory could explain. And in the pursuit of alpha, meanwhile, many have come to see MPT and its associated tools as incongruous and possibly counterproductive.

Since its launch in the fall of 2011, Entrepreneurial investor has featured the scholarship of leading luminaries in behavioral finance, as well as its critics, while our own contributors have added their analysis and perspective to the topic. What follows is a selection of some of our most impactful covers. Taken together, these contributions provide insight into the evolution of financial thinking over the past decade.

Although behavioral finance has helped highlight how modern finance has sometimes overlooked market phenomena, it has yet to present an integrated model to replace it. Whether it ever will is an open question, but perhaps not critical: given the complexity of 21st century markets, this theoretical framework will never encompass the full breadth of market activity may be wishful thinking. But at the very least, as this collection demonstrates, viewing mainstream finance through a behavioral lens can provide critical insight.

Internal advertising for behavioral finance: The second generation

For better ratings, avoid these five behavioral mistakes

Michael Mauboussin believes investors can generate more accurate valuations and improve investment decision-making by avoiding five behavioral pitfalls. David Larrabee, CFA, explains.

Daniel Kahneman: four keys to better decision making

Daniel Kahneman explored some of the key ideas that have driven his scholarship, including intuition, experience, bias, noise, how optimism and overconfidence influence the capitalist system, and how we can improve our decision making, at the 71st Annual Conference of the CFA Institute. Paul McCaffrey provides an analysis.

Richard H. Thaler: To intervene or not to intervene

Richard H. Thaler advises investment decision makers to study the inclinations and biases of all market participants as a means of generating returns. Shreenivas Kunte, CFA, CIPM, considers Thaler’s perspective.

Robert J. Shiller on Bubbles, Reflexivity and Narrative Economy

“Economists want to standardize the understanding of economic events,” explains Robert J. Shiller in a wide-ranging conversation with Paul Kovarsky, CFA. “They want to have a simple model. The problem is that it’s hard to standardize our understanding because ideas change and people’s thinking changes over time.”

Journal of financial analysts Current number mosaic

Meir Statman on the coronavirus, behavioral finance: the second generation and more

Meir Statman discusses the second generation of behavioral finance, how it can inform our understanding of artificial intelligence (AI) and environmental, social and governance (ESG) investing, as well as our response to the recent coronavirus outbreak , among other topics, in an interview with Paul McCaffrey.

Rebirth of active equity

In this series, C. Thomas Howard and Jason Voss, CFA, critique MPT and what they see as its detrimental effect on active management and explain how harnessing behavioral insights could revive the discipline.

The market discovery hypothesis (DMH)

Thomas Mayer, PhD, CFA, attempts to bridge the gap between conventional and behavioral finance with the Discovering Markets Hypothesis (DMH), which he developed with Marius Kleinheyer.

What does loss aversion mean for investors? Not much

Contrary to the conventional wisdom of behavioral finance, the primacy of loss aversion may be overstated, according to David Gal.

Have the behaviorists gone too far?

“It’s tempting, if the only tool you have is a hammer, to treat everything like a nail,” wrote Abraham Maslow. Ron Rimkus, CFA, draws a parallel between Maslow’s hammer and behavioral finance and questions whether it is being applied too broadly.

Tile for Future of Work in Investment Management: Report 2021

How to read financial news: Country of origin, confirmation and racial bias

Few question the prevalence of country of origin and related biases: most will readily acknowledge its existence and admit to being prone to it themselves. However, many of us have a much harder time accepting racial bias as a similarly salient phenomenon that can influence our behavior. Robert J. Martorana, CFA, argues for recognizing and correcting these biases.

Career and Inclusion Now: Action Points for Investment Management

How can the investment management industry better embrace diversity? Machel Allen, CFA, Stephanie Creary and John W. Rogers, Jr. shared their thoughts in a CFA Institute webinar. Lauren Foster and Sarah Maynard distill the keys to take away.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: ©Getty Images/Highwaystarz-Photography

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Paul McCaffrey

Paul McCaffrey is the editor of Entrepreneurial investor at the CFA Institute. He previously served as a publisher at the HW Wilson Company. His writing has appeared in Financial planning i DailyFinance, among other publications. He holds a BA in English from Vassar College and a MA in Journalism from the City University of New York (CUNY) Graduate School of Journalism.

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