quantfinanceclub.com

The Market for Financial Advice: An Audit Study

Do financial advisers undo or reinforce the behavioral biases and misconceptions of their clients? We use an audit methodology where trained auditors meet with financial advisers and present different types of portfolios. These portfolios reflect either biases that are in line with the financial interests of the advisers (e.g., returns-chasing portfolio) or run counter to their interests (e.g., a portfolio with company stock or very low-fee index funds). We document that advisers fail to de-bias their clients and often reinforce biases that are in their interests. Advisers encourage returns-chasing behavior and push for actively managed funds that have higher fees, even if the client starts with a well-diversified, low-fee portfolio.

Link al Paper

Exploiting Option Information in the Equity Market

Abstract: 
Public option market information contains exploitable information for equity investors for an investable universe of liquid large-cap stocks. Strategies based on several option measures predict returns and alphas on the underlying stock. Transaction costs are an important factor given the high turnover of these strategies, but significant net alphas can be obtained when using a simple transaction cost reducing approach. These findings suggest that information diffuses from the option market into the underlying stock market.

Link al Paper

Adaptive Markets and the New World Order

Abstract

The traditional investment paradigm is based on several key assumptions including rational investors, stationary probability laws, and a positive linear relationship between risk and expected return with parameters that are constant over time and which can be accurately estimated. These assumptions were plausible during the “Great Modulation” — the seven decades spanning the mid-1930s to the mid-2000s in which equity markets exhibited relatively stable risk and expected returns — but have broken down during the past decade, implying temporary but significant violations of rational pricing relationships. This tension between rational and behavioral market conditions is captured by the Adaptive Markets Hypothesis (AMH), an evolutionary perspective on market dynamics in which intelligent but fallible investors learn from and adapt to changing environments. Under the AMH, markets are not always efficient, but they are highly competitive and adaptive, and can vary in their degree of efficiency as the economic environment and investor population change over time. The AMH has several new implications for financial analysis, including the possibility of negative risk premia, the transformation of alpha into beta, and the importance of macro factors and risk budgeting in asset-allocation policies.

Link al Paper

Una nota de media mañana. Dinamic Hedge tiene un enumerativo post sobre -ciertas- tendencias que se observan en el mercado de acciones de USA.

(…)

Mutual Fund Monday: Mondays are considered a favored day for institutional buying.  I’m not sure if there is any hard evidence for this, but it is certainly an observable phenomenon in the last couple years.  I rarely fade an into Monday rallies.

4-Year Presidential Cycle: This is a long-term seasonality play that could be categorized under market cycles.  I pay very close attention to this one.  The major premise being that the second year of a presidential cycle can produce a meaningful bottom in the stock market.  The fourth quarter of the second year of a presidency typically produces large gains and the third year produces positive gains in all quarters.  This is in effect right now.

2-Year Tech Product Cycle: This one can also be categorized as more of a market cycle rather than seasonality.  Technology drives productivity.  Semiconductors roughly double their computational capacity every 18 months.   This continuous advancement of computational capacity drives new innovative product cycles. This relentless product cycle translates into roughly two-year observable market phenomenon where technology stocks create relative highs every two years.  Take a look at a chart of the Philadelphia Semiconductor Index SOX, to see what I mean.

(…)

Si desea profundizarse en el tema: Efectos Calendarios

Bubbles, gullibility, and other challenges for economics, psychology, sociology, and information sciences

Gullibility is the principal cause of bubbles. Investors and the general public get snared by a “beautiful illusion” and throw caution to the wind. Attempts to identify and control bubbles are complicated by the fact that the authorities who might naturally be expected to take action have often (especially in recent years) been among the most gullible, and were cheerleaders for the exuberant behavior. Hence what is needed is an objective measure of gullibility.

This paper argues that it should be possible to develop such a measure. Examples demonstrate, contrary to the efficient market dogma, that in some manias, even top business and technology leaders fall prey to collective hallucinations and become irrational in objective terms. During the Internet bubble, for example, large classes of them first became unable to comprehend compound interest, and then lost even the ability to do simple arithmetic, to the point of not being able to distinguish 2 from 10. This phenomenon, together with advances in analysis of social networks and related areas, points to possible ways to develop objective and quantitative tools for measuring gullibility and other aspects of human behavior implicated in bubbles. It cannot be expected to infallibly detect all destructive bubbles, and may trigger false alarms, but it ought to alert observers to periods where collective investment behavior is becoming irrational.

The proposed gullibility index might help in developing realistic economic models. It should also assist in illuminating and guiding decision–making.

Link al Paper

Psy-Fi Blog, tiene un post donde pone el problema de Linda en perspectiva; después ahonda con la critica. Me quedo con el comienzo.

It’s the (in)famous Linda problem:

Linda is 31 years old, single, outspoken and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in antinuclear demonstrations. Which of these two alternatives is more probable?

(a) Linda is a bank teller.
(b) Linda is a bank teller and is active in the feminist movement.

Most subjects choose (b) and are informed that they’re irrational because the conjunction of two events – Linda is a bank teller and active in the feminist movement – is less likely than her just being a bank teller, regardless of her leisure interests. This is known as the conjunction fallacy. Unfortunately there’s a teensy little problem with this finding.

(…)

Here’s a variation of the Linda problem carried out by Gigerenzer and colleagues:

Linda is 31 years old, single, outspoken and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in antinuclear demonstrations.

There are 100 people who fit the description above. How many of them are:

(a) bank tellers
(b) bank tellers and active in the feminist movement

Guess what happens to the results? Yep, the conjunction fallacy disappears – far more participants now choose (a) than (b). Something odd and deep and important is happening that the mainstream of behavioural finance research is completely failing to understand.