1. Simon (1955) wrote, “Broadly stated, the task is to replace the global rationality of economic man with a kind of rational behavior that is compatible with the access to information and the computational capacities that are actually possessed by organisms, including man, in the kinds of environments in which such organisms exist.” (Page 99; emphasis added.) Joan Robinson (1962) debunked the “metaphysical concept” of utility, and Kahneman and Tversky (1979) roundly demonstrated the inadequacy of utility theory.
2. Statman (2011), Introduction.
3. Howard (2013), 5-7.
4. Kahneman (2011), 20-22. Kahneman attributes the terms “System 1” and “System 2” to psychologists Keith Stanovich and Richard West.
5. Howard (2013), 3.
6. In principle, a security’s true value is the present value of projected cash flows discounted at a rate that properly reflects the uncertainty of receiving them in full and on time. Nonetheless, the true value is unobservable, and estimating it is quite unlike guessing the number of marbles in a jar.
7. Surowiecki (2004), 7-8.
8. “By species, I mean distinct groups of market participants, each behaving in a common manner. For example, pension funds may be considered one species; retail investors another; market makers a third; and hedge-fund managers a fourth.” Lo (2004), 23.
9. Sullivan and Xiong (2012).
10. Lane (1991), 108.
11. Howard (2013), 3.
12. Howard (2013), 9.
13. For example, Howard recommends that investors implementing BPM be aware of market sentiment; create buckets for short-term income and liquidity, long-term capital growth, and alternative investments; and select managers on the basis of their strategy, consistency, and willingness to take high-conviction positions. Howard (2013), 18-22, 25.
14. Black (1986), 531.
15. Howard asserts in passing that patterns of short-term momentum and mean reversion “tend to be transitory in nature.” Howard (2013), 25.
16. Research Affiliates investment professionals Ryan Larson (2013) and Vitali Kalesnik (2013), respectively, provide clear and well-supported explanations of momentum and mean reversion.
17. Fama and French (1988), Abstract and pages 3-4.
18. See Kalesnik (2013).
19. They may also be smarter than the average bear. The fascinating study of IQ and trading behavior in Finland conducted by Grinblatt et al. (2012) did not specifically consider intelligence in relation to investment strategy. Nonetheless, the study found that high-IQ investors were more likely than low-IQ investors to hold (sell) stocks that hit a monthly low (high). “High IQ investors thus appear to be more contrarian than low-IQ investors with respect to these reference prices.” This is especially true when extreme price movements occur. Nor is this pattern necessarily motivated by the disposition effect. Citing other studies, Grinblatt and his co-authors state, “by selling stocks at monthly highs and holding stocks at monthly lows, high-IQ investors are more likely to be following a rational liquidity provision strategy than a psychological bias that diminishes returns.” (Page 347.)
20. Quoted in Zweig (2007).
21. Thaler (1999), 15. Benartzi and Thaler (1995) made note of investors’ propensity to check investment performance frequently and attributed the equity premium in part to what they called “myopic loss aversion.” Kahneman (2011) wrote, “The combination of loss aversion and narrow framing is a costly curse. Individual investors can avoid that curse, achieving the emotional benefits of broad framing while also saving time and agony, by reducing the frequency with which they check how well their investments are doing.” (Page 339.)
22. Nuttin (1985), 40.
23. Nuttin (1985), 29.
24. Gjesme (1983) explains the measurement issues.
25. Cialdini (2009), Chapter 4.
26. Smith (1759), III.2.16.
27. Here, too, the social environment matters; even within a single culture and economy, prevalent attitudes change over time. Citing a major study, Lane reports that many more Americans saw the self as efficacious, and independence as a source of well-being, in 1976 than in 1957. Lane (1991), 173.
28. Kalesnik (2013) stated, “It is exceedingly difficult for investors and managers alike to hold fast when the market continues to move against them. One potential solution is to strip contrarian investing of its emotional component by committing long-term assets to a transparent algorithmic rebalancing strategy. Smart Beta strategies—a recent innovation in financial management—are transparent, non-price weighted solutions. Transparency and dispassionate rebalancing rules help significantly mitigate the agency problems facing regular managers.”
Benartzi, Shlomo and Richard H. Thaler. 1995. “Myopic Loss Aversion and the Equity Premium Puzzle.” Quarterly Journal of Economics, vol. 110, no. 1 (February):73-92.
Black, Fischer. 1986. “Noise.” Journal of Finance, vol. 41, no. 3 (July):529-543.
Cialdini, Robert B. 2009. Influence: The Psychology of Persuasion. Revised edition. New York: HarperCollins e-books.
Fama, Eugene F., and Kenneth R. French. 1988. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, vol. 22, no. 1 (October):3-25.
Gjesme, Torgrim. 1983. “On the Concept of Future Time Orientation: Considerations of Some Functions’ and Measurements’ Implications.” International Journal of Psychology, vol. 18, no. 1 (February/December):443-461.
Grinblatt, Mark, Matti Keloharju, and Juhanni T. Linnainmaa. 2012. “IQ, Trading Behavior, and Performance.” Journal of Financial Economics, vol. 104, no. 2 (May):339-362.
Howard, C. Thomas. 2014. “Behavioral Portfolio Management.” (December 31).
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Kahneman, Daniel. 2011. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux.
Kalesnik, Vitali. 2013. “Smart Beta and the Pendulum of Mispricing.” Simply Stated, Research Affiliates (3rd Quarter).
Lane, Robert E. 1991. The Market Experience. Cambridge: Cambridge University Press.
Larson, Ryan. 2013. “Hot Potato: Momentum As An Investment Strategy.” Fundamentals, Research Affiliates (August).
Lo, Andrew W. 2004. “The Adaptive Markets Hypothesis: Market Efficiency from an Evolutionary Perspective.” Journal of Portfolio Management, vol. 30, no. 5 (30th Anniversary):15-29.
Nuttin, Joseph, with the collaboration of Willy Lens. 1985. Future Time Perspective and Motivation: Theory and Research Method. Leuven, Belgium: Leuven University Press and Hillsdale, NJ: Lawrence Erlbaum Associates, Inc., Publishers.
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Smith, Adam. 1759; 1982. The Theory of Moral Sentiments. Edited by D.D. Raphael and A.L. Macfie. Indianapolis, IN: Liberty Fund.
Statman, Meir. 2011. What Investors Really Want: Discover What Drives Investor Behavior and Make Smarter Financial Decisions. New York: McGraw-Hill.
Sullivan, Rodney N. and James X. Xiong. 2012. “How Index Trading Increases Market Vulnerability.” Financial Analysts Journal, vol. 68, no. 2 (March/April):70-84.
Surowiecki, James. 2004. The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies, and Nations. New York: Doubleday.
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