|
© Copyright 2000 Rogers Media. The following article first appeared in the July 2001 edition of
BENEFITS CANADA magazine.
Human Behaviour
The developing field of behavioural finance is calling into question our beliefs about the
efficiency of markets.
By Caroline Cakebread
If you believe that markets are completely rational, think again. In their new book, Behavioral
Finance, Joachim Goldberg and Rudiger von Nitzsch are building on a growing body of new research that
highlights the impact of human behaviour and psychology on the markets. Goldberg, a behavioural finance
specialist, and von Nitzsch, a finance professor at the University of Aachen, challenge the theory that
markets are purely rational and efficient, arguing that emotional and, importantly, irrational factors can
have a major effect on market activity. In fact, behavioural finance should be considered an important
analytical tool.
Most fundamental analysts and economists refuse to get involved in the psychology of market participants.
But technicians in particular should be concerned with human behaviour, not only to calculate market
movements, but also to understand them. A purely numerical study of prices, chart points and trend lines is
far from sufficient.
In Behavioral Finance, the authors draw on research in the areas of psychology and consumer
behaviour to underline their main point-- "Although it is thought that actors act rationally, at least in
their market dealings, reality shows a different picture--people act anything but rationally."
While the concept of behavioural finance may seem far removed from the world of institutional investing, it
poses interesting questions.
"The main challenge that sponsors, consultants and money managers in the institutional world face is that
we make our decisions as humans as opposed to computers," says Harry Marmer, director, institutional
investment services at Franklin Templeton in Toronto. "That means that we are susceptible to many of the
human behavioural patterns, such as overconfidence and pride that impact our decision making. The more we
become aware of the specific behavioural tendencies and how they can skew our decision making, the better
off we are in dealing with them more effectively."
IRRATIONAL THOUGHT
In Behavioral Finance, Goldberg and von Nitzsch explore individual patterns of irrational thought
and the way they affect market participants. For example, they illustrate an innate tendency that people
have--especially in the high-pressure, profit-driven area of investment--to selectively perceive
information. In an age of information overload, this is easy to do. People employ simplifying heuristics
(mechanisms for processing information quickly to produce results) in order to deal with an influx of
information. Decisions made based on this information can easily be skewed and biased.
Harry Gibbs, vice-president, investments, Workplace Safety and Insurance Board in Toronto, says that "The
trick in the investment world is not to let your heart rule and to take that sober second look and react to
that, rather than the first rush. That first rush is likely what the herd is reacting to." Although,
sometimes, the herd can rule for longer periods of time, as in the case of the tech mania, Gibbs believes
that "markets are efficient in the long run and manias that are emotionally driven get corrected in the
marketplace."
In the end, being aware of the impact of emotions on our decision-making process can help investors avoid
following the herd.
Rudy Dabideen, director of investments, Colleges of Applied Arts and Technology Pension Plan in Mississauga
Ont., believes that being aware of the impact of behavioural finance is crucial in today's markets. "Plan
sponsors determine asset allocation based on the assumption that markets are efficient. The concept of
behavioural finance undermines that assumption because it implies that markets are irrational, hence
inefficient." And this can be a big challenge. As Dabideen says, "plan sponsors rely on outside inputs to
make investment decisions, but they are not always rational in their decision-making process."
So, whether or not you believe that markets are purely rational, it would appear that the old saying "know
thyself" still rings true.
Caroline Cakebread is editor of Canadian Investment Review.
ccakebread@rmpublishing.com.
|
News
News
