Investor Decision-Making and the Role of the Financial Advisor (eBook)

Caterina Cruciani holds a PhD in Economics from Ca’ Foscari University of Venice, Italy, where she is currently Postdoctoral Researcher. She is also Operating Director and member of the Center for Experimental Research in Management and Economics (CERME) at Ca’ Foscari University of Venice. Her research focuses on financial institutions, financial advisory, the determinants of trust in the client-advisor relationships, and behavioural finance. Caterina has taught Behavioural Economics at graduate level and Corporate Finance at undergraduate level, alongside an introductory course in Behavioural Finance offered to top professional financial advisors. Her publications are featured in international journals like the Journal of Economic Interaction and Coordination.

Preface 6
Acknowledgements 8
Contents 10
List of Figures 12
Part I: The Investor 13
1: Understanding Investor Behaviour 14
1 Financial Advisory Practice and Investor Behaviour 15
2 The Departure from Traditional Models of Decision-Making Under Risk 17
3 Understanding How People Think Under Risk 21
3.1 The Rationale 21
3.2 Seminal Biases and Heuristics 22
3.3 Other Financially Relevant Biases 27
4 Understanding How People Choose Under Risk 30
4.1 Rationale 30
4.2 Prospect Theory: The Modelling Framework 31
4.3 Prospect Theory: Implications for Behavioural Finance 35
4.3.1 Framing Effects 35
4.3.2 Mental Accounting 35
4.3.3 The Equity Premium Puzzle 39
4.4 Ambiguity Aversion 41
5 Summary and Conclusion 43
Bibliography 44
2: Different Views on Economic Rationality: Affect and Emotions 48
1 Introduction 49
2 Are Biases Truly Irrational? An Evolutionary Perspective 50
3 Emotions and Decision-Making 52
3.1 Rationale 52
3.2 Expected Emotions: Regret Aversion 55
3.3 The Affect Heuristic 56
3.4 Emotional Finance and Financial Advisors 57
4 An Alternative View on Heuristic Decision-Making: Heuristics as Satisficing Responses 59
4.1 Rationale 59
4.2 The Adaptive Toolbox 60
4.3 Finance and Fast and Frugal Heuristics 62
4.4 Evolutionary Foundations of Ecological Rationality 64
5 The Last Piece of the Puzzle: Investor Personality 66
6 Summary and Conclusions 70
Bibliography 71
Part II: The Advisor 76
3: Financial Advisory: Basic Roles and Functions 77
1 Introduction 78
2 The Financial Advice Industry 79
2.1 The Context 79
2.2 Roles and Functions of Financial Advisors: Improving Financial Performance 80
2.3 Additional Roles of Financial Advisory Practice 83
2.3.1 Rationale 83
2.3.2 Information Provision 84
2.3.3 Financial Education 86
2.3.4 Addressing Behavioural Biases 89
2.3.5 The Role of Mediator in Collective Decision-Making 92
2.3.6 Some Concluding Remarks on Ancillary Roles 93
3 A Fiduciary Relationship 93
4 Summary and Conclusions 97
References 99
4: Financial Advisory: Normative Developments and Incentives 103
1 Introduction 104
2 The Financial Advisory Industry: A Historical Overview 106
2.1 Rationale 106
2.2 The American Context 106
2.2.1 Building the Profession 106
2.2.2 Current Challenges 108
2.3 The European Context 110
2.3.1 Creating a Common Financial Market 110
2.3.2 Formal Regulation of the Financial Advice Industry: The MiFID Directive 112
2.3.3 MiFID II: Redefining Financial Advisory Practice 116
2.3.4 MiFID II: Challenges and Opportunities 120
2.3.5 Implementation of MiFID II Across the Member States 121
3 Financial Advisory Practice: Regulation and Behavioural Considerations 122
3.1 Rationale 122
3.2 Implementing the Suitability Requirement 123
3.3 Conflict of Interest 127
4 Summary and Conclusions 132
References 133
Part III: Behavioural Financial Advisory Practice 137
5: Behavioural Financial Advisory Practice 138
1 Introduction 139
2 Operationalizing Behavioural Finance 140
2.1 Debiasing Approaches 140
2.2 Managing Biases 142
3 Behavioural Portfolio Theory 143
3.1 The Antecedents of Behavioural Portfolio Theory 143
3.2 Behavioural Portfolio Theory 147
4 Behavioural Financial Advisory Practices 149
4.1 The Rationale 149
4.2 Minimizing the Impact of Biases 150
4.3 Bypassing Biases: Financial Advisors as Money Doctors 152
4.3.1 The Rationale 152
4.3.2 Modelling Trust 153
4.3.3 Trust and Financial Intermediaries 158
5 Summary and Conclusions 163
Bibliography 164
Index 168