The Financial Consequences of Behavioural Biases (eBook)

Imad A. Moosa is Professor of Finance at RMIT University, Australia. Before coming to academia, he worked in investment banking for a period of ten years. He has published extensively in both economics and finance.Vikash Ramiah is Associate Professor of Finance at the University of South Australia. He has published extensively in behavioural and environmental finance, and he is a research fellow for the Institute of Global Business and Society, TH Köln, and Tianjin Academy of Environmental Sciences.

Preface 6
Contents 8
Abbreviations 9
List of Figures 11
List of Tables 12
1 The Rise and Fall of Neoclassical Finance 13
Abstract 13
1.1Introduction 14
1.2Pillars of Conventional Finance: CAPM 17
1.3Pillars of Conventional Finance: EMH 26
1.4The Failure of Neoclassical Finance 33
References 34
2 The Rise and Rise of Behavioural Finance 38
Abstract 38
2.1Discarding Rationality 39
2.2Sources and Examples of Irrationality 42
2.2.1High Risk for Low Return 43
2.2.2Gambling Against the Odds in a Casino 44
2.2.3Anchoring and Mental Accounting 47
2.2.4The Winner’s Curse 48
2.2.5Irrationality Exposed by Prospect Theory 49
2.3Market Anomalies 51
2.3.1The January Effect 51
2.3.2Other Calendar Effects 52
2.3.3Profitable Trading 53
2.4The Rest of This Book 54
References 54
3 Overconfidence and Self-Serving Bias 56
Abstract 56
3.1The Concept of Overconfidence 57
3.2Some Manifestations of Overconfidence 58
3.2.1Overconfidence and Noise Trading 59
3.2.2Overconfidence and the Forward Premium Puzzle 59
3.2.3Overconfidence and Financial Planning 60
3.2.4Overconfidence and Financial Literacy 61
3.2.5Overconfidence and Financial Distress 61
3.2.6Overconfidence in Mergers and Acquisitions 62
3.3Overconfidence in Working Capital Management 62
3.3.1Overconfidence and Cash Management 63
3.3.2Overconfidence and Inventory Management 64
3.3.3Overconfidence and Debt Management 65
3.3.4Overconfidence and Risk Management 65
3.4The Concept and Detection of Self-Serving Bias 66
3.5Some Manifestations of Self-Serving Bias 69
3.5.1Self-Serving Bias and Retirement Planning 69
3.5.2Self-Serving Bias and Financial Crises 70
3.5.3Self-Serving Bias and Corporate Financing Decisions 72
3.5.4Self-Serving Bias, Accounting Decisions and Financial Reporting Scandals 72
3.5.5Self-Serving Bias and Traders’ Behaviour 73
3.5.6Self-Serving Bias and Corporate Governance 74
3.6Conclusion 75
References 76
4 Loss Aversion Bias, the Disposition Effect and Representativeness Bias 81
Abstract 81
4.1Introduction 82
4.2Loss Aversion Bias 83
4.2.1Detecting Loss Aversion Bias 83
4.2.2Loss Aversion and the Equity Premium Puzzle 84
4.2.3Loss Aversion and Optimal Portfolio Choice 85
4.2.4Loss Aversion and Financial Crises 85
4.2.5Loss Aversion and Financial Planners 86
4.2.6Loss Aversion and Corporate Treasurers 86
4.2.7Loss Aversion and PGA Tour Players 87
4.3The Disposition Effect and Prospect Theory 87
4.3.1The Disposition Effect and Dividend Policy 88
4.3.2The Disposition Effect and Ostrich Effect 89
4.3.3The Disposition Effect and Gender Bias 89
4.3.4The Disposition Effect in the Chinese Market 90
4.3.5The Disposition Effect, Momentum and Contrarian Trading Strategies 90
4.4Representativeness Bias 92
4.4.1Representativeness Bias and Over-Reaction 93
4.4.2Representativeness Bias and Other Financial Consequences 95
4.5Conclusion 95
References 96
5 Other Biases in the Behavioural Finance Literature 103
Abstract 103
5.1Gambler’s Fallacy 104
5.2Hindsight Bias 109
5.3The Phenomenon of Panic 110
5.4Herd Behaviour 111
5.5Status Quo Bias 112
5.6Survivorship Bias 116
5.7Money Illusion 119
5.8Attachment Bias 122
5.9Familiarity and Home Bias 123
5.10Illusion of Control 125
5.11Conservatism Bias 127
5.12Narcissism 127
5.13More Where This Came from 130
References 131
6 Recent Developments 135
Abstract 135
6.1Introduction 136
6.2Ecological Finance 137
6.3Quantitative Behaviuoral Finance 141
6.4Experimental Finance 147
6.5Neurofinance 151
6.6Emotional Finance 153
6.7Future Prospects 156
References 157
7 Epilogue 161
Abstract 161
7.1The Fall of Neoclassical Finance—Once More 162
7.2The Persistence of Neoclassical Finance Under Publish or Perish 163
7.3Behavioural Biases and Conspiracy Theory 165
7.4Concluding Thoughts 169
References 171
Glossary of Behavioural Biases 173
Index 183