Back to Drew's Views
December 11, 2019
Previous
Next

Behavioural Finance is Finance

Behavioural Finance
Asset Pricing

Last week, Barry Ritholtz had a fun interview with Eugene Fama (and David Booth) [1].  In it, Gene threw out a few provocative zingers, like this one:

“I’m the most important person in behavioural finance…because most of behavioural finance is just a criticism of efficient markets.  So, without me, what have they got?”

Dick Thaler couldn’t resist with his own witty retort on Twitter:

Beh Fin is Fin 1.png
The most important person in behavioural finance?

Gene dropped some other one-liners (actually he was very entertaining), and stated that behavioural finance had been a “failure” because they hadn’t come up with a “testable theory” in Gene’s mind.

Gene: “When I put the challenge to him (Thaler) 20 years ago, I said, okay now, you’ve been criticizing us for the last whatever (years); time (for you) to come up with a theory that we can actually test, and see if it works or not.”

Barry: “And what was his response?”

Gene: “I’m still waiting.”

Like-minded folks like Lu Zhang, an efficient market economist at Ohio State, followed up with a blog [2] stating:

“It has been almost 35 years since De Bondt and Thaler (1985), yet there is still not a single coherent behavioural theoretical framework in sight.”

Is that the standard for these EMH guys?  Does behavioural finance need to figure out a model of market equilibrium that makes markets efficient?  Isn’t that a bit of a diversion?  

Hasn’t behavioural finance actually provided a theoretical underpinning for many of the most successful “factors”?  Hasn’t behavioural finance made relevant these theory-less multi-factor models of market equilibrium?  Sure, there is more to do, but hasn’t behavioural finance had a great start?

Finally, back to the Ritholtz interview, Fama reiterated his earlier point:

“There is no behavioural finance. This is all just a criticism of efficient markets, with no evidence.”

Well, there sure is behavioural finance.  It’s also called finance.  And it’s provided plenty of evidence that markets don’t always get things right.  And frankly, there is very little supporting evidence of the risk story behind many of Fama and French’s proposed factors.  Size?  Maybe (big maybe).  But why is value riskier than growth?  Why are firms with better gross profitability riskier than those that are less profitable? Why are firms that efficiently invest capex more risky?

And perhaps a more important, and bigger, question: why didn’t Fama and French include momentum in either their three or five factor models? [3]  They know it’s there. They know it’s a thing.

The answer, because there is almost no possible risk explanation for momentum [4].  The behavioural guys have plenty of reasons.  They have common sense, intuitive reasons; motives like loss aversion, confirmation bias, anchoring and herding.  Even Fama himself has admitted that momentum “is an embarrassment to the theory”. [5]  Momentum isn’t embarrassing for Narasimhan Jegadeesh, Sheridan Titman, Cliff Asness, or Mark Carhart.  Momentum isn’t embarrassing for those who know that behavioural finance hasn’t been a failure.  For those guys, momentum is beautiful.

Behavioural finance is finance.  That individual human beings can sometimes do silly things, for reasons to do with either nature or nurture, is not under dispute.  That they may make these same mistakes in the aggregate is no longer heretical.  That is the gift of those that have been “misbehaving” by attacking hallowed, efficient market doctrine.  Economists now can consider potential irrationality versus a standard model of profit-maximizing utility without being disinvited to (those wild and crazy) economist parties.  Economists can now suggest that cognitive biases can affect asset prices without threatening their tenure.

Behavioural economics is no longer the domain of rogue traitors attacking efficient market theory.  Behavioural economists are the patriots of finance.  

So let’s just (finally) drop the “behavioural” from the term.  We’ve had almost precisely 20 years since Dick Thaler suggested the same thing himself:

“I predict that in the not-too-distant future, the term "behavioural finance" will be correctly viewed as a redundant phrase. What other kind of finance is there? In their enlightenment, economists will routinely incorporate as much "behaviour" into their models as they observe in the real world. After all, to do otherwise would be irrational.” [6]    

Subscribe and sign up with your email address to receive the latest news and updates
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

FOOTNOTES

[1] https://www.youtube.com/watch?v=HRNczGwcTVQ

[2] http://theinvestmentcapm.com/blog.html

[3] https://www.aqr.com/Insights/Perspectives/Fama-on-Momentum

[4] Fama’s story here has migrated to momentum being risky because it occasionally has discontinuous downward jumps.  It isn’t impossible that he is right, but this seems like a tautologous cop-out.

[5] https://www.top1000funds.com/2015/12/investors-from-the-moon-fama/

[6] Thaler, The End of Behavioural Finance, Financial Analysts Journal, Vol. 55, No. 5, Behavioural Finance (Nov.-Dec., 1999), pp. 12-17

Download PDF

Topics

Behavioural Finance
Asset Pricing

DISCLAIMER

The views and opinions expressed in this post are those of the post’s author and do not necessarily reflect the views of Albert Bridge Capital, or its affiliates. This post has been provided solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The author makes no representations as to the accuracy or completeness of any information in this post or found by following any link in this post.

YOU MIGHT ALSO LIKE

Text Link

Heading

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Suspendisse varius enim in eros elementum tristique. Duis cursus, mi quis viverra ornare, eros dolor interdum nulla, ut commodo diam libero vitae erat. Aenean faucibus nibh et justo cursus id rutrum lorem imperdiet. Nunc ut sem vitae risus tristique posuere.

Text Link
Text Link

OK, 2022 Was a Disaster for Tesla - What Next?

There still could be significant downside, but it's going to take fundamental misses to get there; and $TSLAQ has to admit that the screaming short at $400 has fallen 70%.

Markets
Behavioural Finance
Read More
Text Link

Stock Market History, Illuminated, 2022 Style

I’ve been keeping a graphic of the long-term performance of the US stock market for many years now, and I’ve been sharing this information in the histogram below. I think it does a reasonable job of revealing how long-term returns are manufactured and the tilts over time. I’ve color-chunked the data by decade to highlight decades of historical weakness as well as periods of strength. I’ve also added additional tables and charts which I think are interesting, and in some cases, stunning.

Asset Pricing
Factors
Markets
Valuation
Read More
Text Link

What Stands in the Way Becomes the Way

I don’t think that Aurelius, Frost or Zweig would disagree that the road less traveled might have a little more alpha in it.

Markets
Behavioural Finance
Stock Picking
Read More
Text Link

Interest Rates and Growth Stocks

It's very possible, if not likely, that the move in growth stocks from 2017 through 2020 probably wasn’t caused or justified by a move in interest rates, but that people believed, and acted like, it was.

Asset Pricing
Factors
Behavioural Finance
Valuation
Read More
Text Link

For Investors, a "Never-Sell" Mantra is a Song for Fools

On the misleading claims of Hendrik Bessembinder about diversification; and the convenient, post-hoc, and the spurious conclusion to always buy and hold.

Asset Pricing
Markets
Portfolio Management
Stock Picking
Read More
Text Link

A Conversation between Drew Dickson and Morgan Housel

A discussion between Drew Dickson of Albert Bridge Capital, Morgan Housel of The Collaborative Fund; moderated by Jamie Catherwood of O'Shaughnessy Asset Management

Asset Pricing
Behavioural Finance
Markets
Read More
Navigations
HomeTeamDrew's viewsPressContact
Disclaimers
Legal & regulatoryPrivacy policyCookies policy
How to get in Touch
info@albertbridgecapital.com

Subscribe to Drew's Views

No spam. Unsubscribe anytime.
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
© Albert Bridge Capital 2022
Website by SW10media.com
homeTeamdrew's viewspressCOntactDisclaimers