People come in all different shapes, sizes, and colors. If that is the case why are we so similar? The goal of this paper is to discuss people and their behavior as applied to finance. I will attempt to deconstruct human psychology to evidence their patterns. I was twelve years old when I was introduced to the stock market. 1998 had seen significant growth underpinned by a stable political environment. My young mind recalls the irrational exuberance of the adults in my world. You put money in the stock market because it goes up they said. In my investments class in 7th grade a tech stock rose 2000% in one week investing through the Yahoo finance simulation. Likewise, the rest of my classmates pursued other tech companies in an effort to be competitive with one another. I often reflected on the environmental causes of behavior. My fascination with numbers and finance stayed relatively stagnant up to college until corporate finance. It was then that I saw fellow student’s exhibit peculiar behavior again. This time, it was because they were asked to methodically apply algebra and numbers. It was odd to me that everyone used a calculator to solve the problems. They would say, “I put the right numbers in and this is what the calculator gave me.” As I have aged, that statement has become a red flag. Some classmates could solve algebraic problems. However, they did not understand them. I believe these traits are endemic of the overall human condition and run over into all aspects of finance. People are more upset by losses then they are by equal gains according to Kahneman and Tversky’s prospect theory (1979). Human beings are risk adverse creatures. We are willing to give up a large amount of upside to insulate from any downside. The No...
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...yet human, investor would be wise to consider the behavior of their fellow humans and themselves when making an investment decision.
Works Cited
1. Momentum: Narasimhan Jegadeesh and Sheridan Titman; October 23, 2001 2. From Efficient Market Theory to Behavioral Finance: Robert J. Shiller, Cowles Foundation Discussion Paper No. 1385; October, 2002 3. Behavioral Finance: Robert J. Bloomfield, Johnson School Research Paper Series #38-06; October, 2006 4. Efficient Capital Markets: A Review of Theory and Empirical Work: Eugene F. Fama, The Journal of Finance, Vol. 25, No. 2, May, 1970 5. Naive Diversification Strategies in Defined Contribution Saving Plans: Shlomo Benartzi and Richard H. Thaler, The American Economic Review; March, 2001 6. Prospect Theory: An Analysis of Decision under Risk: Daniel Kahneman and Amos Tversky, Econometrica, Vol. 47, No. 2. ; March 1979
...al portfolio based on risk preferences, personal constraints and investment objectives following the Mean-Variance Theory. We have applied a CPPI strategy to allocate assets dynamically over-time and highlighted its superiority compared to the Market and Benchmark Portfolios. We have used both classical (e.g. Sharpe Ratio) and advanced performance measures (e.g. T2, Omega Ratio). We have identified that much of the portfolio’s performance can be attributed to the Selection Effect. The significant MoM indicates the presence of Momentum Effect in the portfolio’s returns. We have highlighted the contribution of Omega Ratio in modern portfolio management because of its ability to capture Higher Moments. Overall, we conclude that insurance strategies, such as CPPI, can be quite useful when investors seek insurance against rapid falls in the market and crash in equities.
First of all, it is noteworthy to point out that these stories have different assumptions about human incentive and their thought process. As behavioral economists, Akerlof and Shiller believe people are driven by confidence, “when people are confident they go out and buy; when they are unconfident they withdraw, and they sell” (13), Akerlof and Shiller then further elaborate on this idea, they insist that we made certain decisions “straight from the gut” because they “feel right” (13-14). Notice this type of thought process and decision making are no different than our own instinct, thus we can conclude that confidence is simply our instinct. On the other hand, Panic and the movie Wall Street are showing a more traditional approach to microeconomic, they both indicated that the primary motivation of decision making is greed or selfishness. In the movie Wall Street, Gekko offers his words of wisdom in a Teldar stockholders meeting, he told the audience that “greed… is good. Greed is right. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed has marked the upward surge of mankind, will not only save Teldar Paper but that other malfunctioning corporation, called the U.S.A.” (Wall
Finance is looked upon as a true technical and analytic subject by outsiders, and even by some insiders, but is it only just that? Does the finance professionals prefer to be seen as true math geniuses, when in reality luck has played a way bigger role in their successes? How do biases, probabilities, habits, our mind and other disciplines factor in? How about luck? Not only is the financial sector truly a summation of those factors, but other sectors and aspects of our daily lives are also subject to those forces. While we may not always understand how the world is shaped around us, reading the 5 books provides a way to be an outsider in our own discipline, how great! Through Hagstrom, Kahneman, Taleb, Haidt, and Duhigg, there is a very real
Chris Gardner, a salesman who sells bone density scanners, struggled to support his family financially but it proved to be an arduous task as most hospitals considered the scanners to be an unnecessary and expensive luxury. Being unable to sell the bone density scanners, Chris ran into hardships in paying for rent, parking tickets, and daycare fees for their son, which caused his wife to become emotionally distressed. On one of his trips to sell the scanner in town, he encountered a person owning a red Ferrari and several happy successful people in front of an office building, which inspired his determination in becoming a stockbroker. He had the ability to work well with people and calculate numbers, and college education wasn’t required, hence this seemed to be a feasible goal even if his wife did not support the idea.
This assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:
In the financial sector, decisions must be made in split seconds that can result in either vast profits or significant losses. The collapse of Lehman Brothers, demonstrated to me the vulnerability of all businesses as the size and level of profit does not matter as poor decisions can still create loss. Making financial decisions is intriguing to me as I ultimately would like to apply my mathematical ability into a career in finance. The concept of investment is interesting to me as it involves calculated risks which depend on an array of mathematical equations to ensure that companies make well informed decisions on how they invest their money. When studying mathematics and finance at university I am keen to understand how to make viable financial decisions and calculate these risks in the context of different business models.
“One of the very nice things about investing in the stock market is that you learn about all different aspects of the economy. It's your window into a very large world,” Ron Chernow once said. The stock market is undoubtedly an incredibly important economic feature, one that our modern world depends on. Indeed, the stock market is so integral to our life today that it can serve as a valuable tool where financial literacy is concerned. Two of the most important financial lessons that the stock market teaches are financial literacy terminology as well as a historical understanding of stock market institutions. The Stock Market Game simulation serves to teach these lessons in a secure environment, and
The second lesson concentrates on the importance of financial literacy. There is one rule to follow so as to understand financial literacy – “Know the difference between an asset and a liability, and buy more assets.” In order to do this, you need to be able to understand and comprehend numbers instead of jus...
Hensel, C. R., Ezra, D., & Ilkiw, J. H. (1991). The Importance of the Asset Allocation Decision.
Every day people undertake some kind of financial transaction, whether it is checking receipts, counting change, checking balance at the ATM or paying a bill. Sometimes, consumers have to undertake more complex financial transactions, such as opening a bank account, taking out a mortgage or comparing saving accounts (Marcolin & Abraham, 2006). Welsh Assembly Government (2007) added that a person with poor basic numeracy skills and poor financial skills will find it increasingly difficult to function in today’s society. Competition is fierce – individuals are constantly being sent information on new financial products and services and financial institutions are keener than ever to sell their products. Therefore, they must have the skills, knowledge, capabilities and confidence to evaluate and compare financial products and services, in addition to managing simple, day-to-day financial tasks.
A crucial reason in favour of mental accounting and overconfidence is decision efficiency. Real-life investing scenario changes every moment Time-consuming and systematic thinking process seldom is allowed during the intense decision-making (Stewart Jr et al., 1999, Busenitz and Barney, 1997). Additionally, the ‘small world’ used by the economic theory, which only applied to strict condition, is not necessarily applicable in the practical investment decision. As the assumption in those analysis approach may not conform with real life well and for most of times, cognitive heuristics is more suitable for the uncertainty(Gigerenzer and Gaissmaier, 2011). However, there is also a few argument against them, for it may hinder people from examining their investment choice thoroughly. Research shows that they did not perceive themselves as risk taker, but in fact, they are more likely to take relatively low return alternatives as ‘opportunities’, indicating that they are risk-taking to a great extent(Palich and Ray Bagby, 1995). As a result of the illusion created by such factors, decision makers tend to be narrow-minded in composing strategies and unable to bring enough information into thought(Schwenk, 1988). It was demonstrated by several researches that decisions made by means of biases and heuristics impose
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
I became an enthusiast of finance ever since I was at high school. At the political economy class, my teacher asked us: if you have a million RMB, how would you use it? She then introduced us the concept of investment, and I was intrigued specifically by the stock. For the latter two years of my high school, I have been reading books and articles regarding the stock market in the U.S. and in China. As one of the outstanding students ranked top 1% in College Entrance Exam in Hainan Province, China, I was accepted by the City University of Hong Kong with a full scholarship. With the strong interest in finance, I chose quantitative finance and risk management as my major.
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.
Never have I ever climbed a mountain peak. As a child, I imagined myself conducting expeditions in deep-frozen pathways, leading amateur explorers to the top of the world, and instructing rookies in surviving harsh blizzards. Even though slightly altered, my childhood dream has been achieved. I led a team of fellow classmates, in my Strategic Management course, to the success summit of a financial competition. Over the course of a semester, I and my teammates were supposed to create and manage a company of the IT industry, in a computer-simulated environment, along with other four rival teams. I dealt with strategy and financial matters of our virtual enterprise, while my colleagues were working on marketing and manufacturing. During the four months of the exercise, I have experienced finance from various aspects: capital budgeting, through selecting favorable investment for upcoming quarters; debt management, by assessing the necessary amount and efficiency of loans; profitability analysis and dividend policy, which had been used to compile the company’s general performance index. Working in a multinational team, which included an American, a Norwegian and a Moldovan, strengthen my negotiations skills, as well as flexibility and cooperation. But above all, this experience intensified my passion for finance. Of course, a pleasant bonus was the fact that, in the end, our company’s financial performance was six times the performance of second-best team.