Volume 7, Number 2, 2006 Abstracts
© Copyright Erlbaum 2006

Searching for Rational Investors in a Perfect Storm: A Behavioral Perspective
Louis Lowenstein-Columbia University

Disentangling Cognitive Bias in the Assessment of Investment Decisions: Derivation of Generalized Conditional Risk Attribution
Noriyuki Okuyama-Pareto Investment Management Limited in London
Gavin Francis-Pareto Investment Management Limited in London

Conventional performance measurement methods concentrate on investment outcomes rather than the underlying investment process. This paper examines the effectiveness of the investment process by considering the essential part of any investment strategy: the investment decision. As recognized by Kahneman and Tversky [1979], the essential first step is to decompose returns into gains and losses. Using a fundamental investment decision matrix broadens the analysis beyond realized gains and losses to include an assessment of missed opportunities and losses avoided. This leads to an examination of investment strategies in terms of investment success versus error. We contrast these terms with traditional return and risk measures. The second step is to decompose investment decisions into the mutually exclusive categories of risk-taking and risk-reducing. Uncertainty observed in risk-taking activities is newly created at each manager's discretion, while the uncertainty in risk-reducing activities is already defined by an investor's portfolio. The conventional performance measurement approach fails to differentiate between these two types of decisions. The contrast between passive and active management styles of risk reduction becomes apparent from the perspective of investment success and error, particularly when using currency risk management as an illustration. Active information diagrams describe a geometric approach called conditional risk attribution. An active manager's skill lies in the ability to use information to maximize investment success and therefore minimize investment error. The choice of benchmark determines the degree of visibility of an investment exposure. We also address the problem of distinguishing between an active manager's skill and the uncontrollable impact of market movements. Having adjusted for the bias in an investment environment, it becomes possible, as a final step, to measure the information content of an active manager's strategy as the balance between investment success and error within a generalized conditional risk attribution framework. The unlimited nature of risk-taking decisions is evident when they are included in the framework. However, having defined an ex ante risk-taking limit, we can assess whether the choice of active manager has resulted in an enhancement of investment success over error. This allows investors to compare risk-taking managers with risk-reducing managers in the context of overall portfolio construction. The entire analysis is framed in terms of risk budgeting to demonstrate its general application to all asset classes and consequently to enhance total portfolio returns within the predetermined loss budget.

Money Attitude Typology and Stock Investment
Carmen Keller-University of Zurich
Michael Siegrist-Swiss Federal Institute of Technology in Zurich

This study identifies segments of individual investors based on their money attitudes (attitude toward financial security, attitude toward stock investing, obsession with money, perceived immorality of the stock market, attitude toward gambling, interest in financial matters, attitude toward saving, frankness about finances). A cluster analysis of data from a representative mail survey conducted in Switzerland (N = 1,569) yielded four main segments of individual investors we term safe players, open books, money dummies, and risk-seekers. This typology has forecast value for behavior: Each type differed with regard to having investment portfolios, buying and selling securities, risk tolerance for maximization of capital, response to price fluctuations, and willingness to make environmentally and socially responsible investments.

Expanding the Range of Behavioral Factors in Economic Simulations
H. Joel Jeffrey-Northern Illinois University

Economic simulations typically focus almost exclusively on economic variables. If non-economic factors are included at all, it is usually in some form of utility function calculation. This paper presents a model that allows formal specification of a much broader range of factors, processes, and quantities involved in human communitiesófamilies, businesses, ethnic groups, nations, work teams, cultures. The phenomena include the hierarchically structured social practices of the group, the principles that underlie choices in the community, and the recognizable positions or statuses in the community. This allows us to model intrinsic or expressive behavior, capturing the concept of multi-aspect identity and the impact of the principles of the group on individual behaviors, all in formal and quantitative form. Having these factors represented formally enables the creation of significantly more realistic simulations incorporating a much wider range of variables, particularly when the economic facts and quantities of interest are affected by and affect several other kinds of factors that are not, on their face, economic.

The Disposition Effect and Individual Investor Decisions: The Roles of Regret and Counterfactual Alternatives
Suzanne O'Curry Fogel, DePaul University
Thomas Berry-DePaul University

Recent studies have documented a strong tendency for individual investors to delay realizing capital losses, while realizing gains prematurely (Odean [1996], Shefrin and Statman [1985], Weber and Camerer [1996]). This tendency has been termed the "disposition effect." The disposition effect is inconsistent with normative approaches to stock sales, such as those based on tax losses (see, for example, Constantinides [1983]). We surveyed individual investors, and found that more respondents reported regret about holding on to a losing stock too long than about selling a winning stock too soon. This finding suggests that individual investors are consistently engaging in behavior that they have been warned can cost them money and that they regret later. Two additional experiments confirm the disposition effect and the role of regret, and offer evidence about the role of an agent (broker) in the assignment of blame and regret. We show that investor satisfaction and regret are not simply functions of outcome, but are influenced by counterfactual alternatives and the type of action taken (holding versus selling). We suggest that the disposition effect may be highly related to reduction of anticipated regret.

Research Elsewhere
Robert A. Olsen-California State University and Decision Research in Eugene, Oregon