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1、Behavioral Finance at JP Morgan,Lets play a game!,Guess 2/3 of the average of the class numbers!,Agenda,Behavioral Finance,Philosophy:Irrational investor behavior leads to market anomalies that can be exploited with a disciplined trading approach.Behavioral investing is based on research into human
2、behavior in financial markets.,Behavioral Finance,1980s:Anomalies in stock prices and new behavioral finance theory,1992:JP Morgans first behavioral finance mutual fund in London,Late 1990s:Offers wider range of mutual funds in U.K.and Europe,2003:JP Morgan launches behavioral finance in the U.S.,La
3、te 2006:AUM in behavioral funds over$20 billion in the U.S.Over$76 billion worldwide.,Approaches to Investing,Approaches to Investing(contd),Research Model PlatformBottom-up approach,based on analysts forecastsDividend Discount ModelRankings form basis for portfolio,Manager Driven PlatformCombines s
4、kills of analysts with experienced portfolio managersFundamental analysis,Approaches to Investing(contd),Approaches to Investing(contd),Behavioral PlatformSeeks to add value byIdentifying anomalies in pricingConsistencyDiversification,Strategies in Behavioral Finance,MomentumValueEarnings SurpriseMe
5、rgerApparent High Risk,Behavioral Platform(contd),Investment processA multi-factor model is used to create portfolios based on factors such as price momentum,earnings momentum,value and growthApplied to a range of stock types,Behavioral Platform(contd),Stocks are screened for growth and value charac
6、teristics,Performance of Intrepid Funds,Difference between Intrepid Funds and Lipper Benchmarks by Style(Jun 2006),Performance of Intrepid America,Performance of Intrepid Growth,Performance of Intrepid Value,Performance of Intrepid Mid-Cap,Benefits of Behavioral Finance,Repeatable,disciplined proces
7、sIncreased return potentialAdded layers of diversificationComplements traditional funds,Our Preference,Behavioral Biases,Overconfidence E.G.Fadi Kanaan&Dirk Jenter-“CEO Turnover and Relative Performance Evaluation”Prospect Theory Allais Paradox,Behavioral Biases(contd),Recency Effect Overreaction&Av
8、ailability Bias E.G.Werner De Bondt and Richard Thaler-Does the Market Overreact?“Herd Behavior,Behavioral Biases(contd),Gamble FallacyConfirmation Biases Mental AccountingAnchoring E.G.Kanheman&Tversky-“Judgment Under Uncertainty:Heuristics And Biases”,Market Anomalies,Cheap Stocks outperform Expen
9、sive Stocks High B/M ratio,low P/E ratio,low P/S ratioStocks continue moving in the same direction News is not immediately reflected,Market Anomalies(contd),Equity Premium PuzzleGood news leads to Overly High Stock Price Bad news leads to Too Low Stock PriceMispricing,Market Anomalies(contd),Winning
10、 stocks tend to be overpriced Calendar Effect December&January Effect,“Linkages”,Cheap Stocks Outperforming Expensive Stocks,Overconfidence&Herd Behavior,Overpaying for perceived good companies and ignoring supposedly bad ones,Recency Effect,Investors assess future prospects based on recent past res
11、ults,Stocks continue moving in the same direction,“Linkages”(contd),Prospect Theory,Investors need more premium to invest in riskier assets,Equity Premium Puzzle,News is not immediately reflected in forecasts,Analysts dismiss new info that contradicts original assessment,Anchoring&Confirmation Biase
12、s,“Linkages”(contd),Prospect Theory,Gamble Fallacy,Hold on to losing stock and sell winning stock,Mispricing,Overreaction&Availability Bias,Heavily weight decisions toward more recent info,making any new opinion biased toward that latest news,Good news drives stock price up by too much&bad news driv
13、es stock price down by too much,“Linkages”(contd),Mental Accounting,Investors discount previously winning stocks at lower rate and vice versa,Winning Stocks tend to be overvalued,Investors want to avoid tax,Calendar Effect,Applications,Cheap Stocks Outperforming Expensive Stocks,Winning Stocks tend
14、to be overpriced,VALUE INVESTING,Applications(contd),Stocks continue moving in the same direction,News is not immediately reflected in forecasts,Good news drive stock price up&bad news drive stock price down,MOMENTUM INVESTING,Benefits of Value Investing,Benefits of Momentum Investing,Arbitrage,Mark
15、et anomalies are caused by either behavioral biases or institutional imperfections,e.g.inefficient markets,temporary supply and demand imbalancesBehavioral biases and anomalies exist in all 3 forms of the efficient market strong,semi-strong,and weak Will they continue to exist or be arbitraged away?
16、,Arbitrage(Contd),Arbitrage(contd),Arbitrage(contd),EMH vs Behavioural Finance,EMH states that behavioural biases and market anomalies will be arbitraged away by rational investors.Also assumes that markets make unbiased forecasts of the futureBehavioural finance argues that arbitrage profits can be
17、 made,but also acknowledges that there are limits to arbitrage.Assumes that in some instances,financial markets are informationally inefficient,Competitors Moving In,Perfect competitionNo barriers to entryMore funds in the market will competeFund managers will move fast to exploit them,Competitors M
18、oving In(contd),Anomalies will continue to exist due toLimits to arbitrageMisvaluationsFundamental RiskImplementation CostsModel RiskRisk AversionLaw of One PriceIrrational investors,Limits to Arbitrage,MisvaluationsRecurrent&Short termArbitrageable,trading strategies can make moneyDifficult to crea
19、te strategies to reliably make moneyHedge funds target these misvaluationsNon repeating&Long termHard to identify peaks&troughs until its over,Limits to Arbitrage,Fundamental RiskBuy undervalued stockBut price may continue to fallTraders investment horizonImplementation CostsShort selling,security r
20、ecallTransaction costs,Limits to Arbitrage,Model RiskProfit opportunity might be more apparent than realModel used to value stock might be faultyRisk AversionLaw of One PriceIdentical assets should have identical prices,Royal Dutch&Shell,Royal Dutch&Shell(contd),Irrational traders,Overconfidence=bea
21、r more risk and hence earn greater expected returnsOverconfidence=aggressive tradingcauses rational agents to scale back trading activity,Conclusion,Anomalies will continue to exist due to limits to arbitrage and irrational tradersForces of arbitrage works well for recurring events but works poorly
22、for non-repeating eventsBehavioral finance is in its infancy and will become more significant in mainstream finance,RECAP,Approaches to investingDifferent platforms Behavioral investment processes and its performanceBiases and anomaliesLinkages between themEMH vs Behavioral FinanceFuture of Behavioral Finance,THE END!,
