Wednesday, October 31, 2007

FREE Financial Psychology Tests

All of our online financial psychology tests are now free! This offering should last for at least one year.

As part of our constant efforts to understand how beliefs, values, personality traits, and even cognitive processing skills (see the Trader's Brain Scan!) drive financial decisions, we've been gathering research data from thousands of users of our online tests.

Our tests are grouped according to interest and affiliation:
Tests For Everyone
Tests For Wealth Management
Tests For Investors
Tests For Traders

We are planning on publishing some of our initial results with collaborators at Stanford University's psychology department in the next few years (we'll write a white-paper once the results are ready). We've learned a lot about how the mind impacts financial success, and we'll be sharing those findings via our academic affiliations over the next few years.

Best wishes,

Friday, October 19, 2007

Rising Fear, China, and Applied Behavioral Finance

The MarketPsych Fear Index is rising (it was already fairly high before today's selloff). Apparently there was a considerable amount of nervousness before the market opened today, and that nervousness escalated into outright fear by day's end. Maybe a front-page (C1) WSJ article about buying on dips sowed doubt in investors today. "When Crash Means Buy" - brings out the Chicken Little in me.


There was no useful info in the WSJ article (such as when to buy on dips and when not to), except that it sowed doubt about what has seemed a surefire strategy. Essentially, since buying on the dips has worked so well for so long (definitely since 1987, excepting the 2 1/2 years for tech stocks after 2000), many investors have become used to increasing their position sizes every time there is a downturn in shares. The article is a little ominous, and certainly hit the market at an already nervous time.

SIVs are the newest "What the...?" to come to the attention of the market. And uncertainty is almost always a negative, especially when the cause is interminably murky and needs $100 billion bailout packages organized by the largest global banks. Once the damage of SIVs comes to light, then the market can rally again, but for now it doesn't look good that another hidden risk has emerged to damage the financial sector.


If you've been a regular visitor to our website since it opened - which is doubtful :), then you've known that I've always been bullish on China, and even set up an Investing in China webpage in 2004 to facilitate research. As I mentioned last month, the market is topping now (though may have a little more juice until February, after which it's best to steer clear). Appears that Hong Kong H-shares are doing spectacularly as an arbitrage play. Also via the WSJ (fine journal, that).

As long as Hong Kong remains in anticipation of local Chinese monetary inflows (and as long as it hasn't started arriving), then that market (especially H-shares) will have upside pressure. Ironically, Chinese investors are having tremendous difficulty opening accounts in the one city where outflows to the Hong Kong markets will be permitted (Tianjin Binhai New Area), and the pilot program was ultimately postponed, so no Chinese cash has made it to Hong Kong legally yet. But that is the genius of the Chinese authorities. By announcing the impending program, the premium of A-shares over H-shares has started to dissipate. And if history is any guide (as when the Chinese gov't announced in late Feb 2001 that the B-share markets would open to local investors in June 2001), then the actual financial inflows from China will probably mark a medium-term top in both markets.


What's the use of behavioral finance? That's the motivating philosophy behind a wonderful organization in Los Angeles -- the Behavioral Finance Working group of the CFA society. Here's their discussion group online.

I was fortunate to give a talk to the group yesterday. I met some great people and got lots of new ideas about how to apply behavioral finance to several areas:
1. Defeating you own investing biases.
2. Helping advisory clients to understand and avoid making biased decisions.
3. Finding opportunities in the markets.
More about those in upcoming posts...

Happy Investing,

Tuesday, October 02, 2007

Neuroeconomics 2007 -- Happenings at the SFN Annual Conference

As if Boston wasn't brainy enough with 51 colleges and universities (see this list), the annual neuroeconomics conference was held there this past weekend. Excellent new neuroscience research gave the audience's grey matter some delightful brain candy to chew on all weekend. I'll just list a few of the fascinating findings below. There are many more that I will not mention for space reasons.

In an effort to break the conference's three days of presented research down into a bullet-point-speckled summary, I'll organize the studies in the three following categories:
1) How people, on average, make personal financial decisions. Such experiments manipulated conditions of risk, reward, punishment, and ambiguity or uncertainty in order to see what types of brain activity correlate with (or even better, predict), not-mathematically-rational financial decisions.
2) How people make social financial decisions. These are often simulated using strategic games played with others (or computers dressed as others) and are relevant to morality in general. Such decisions affect other people (and usually oneself) financially.
3) How people are different from one another in their financial decisions, especially in regards to the brain activity that leads to their different choices under similar conditions.

Under personal financial decisions, Peter Bossaerts excellent (and intricate) study of traders in a simulated market was one of the most fascinating. He found that excellent trading (in this case, based on "tape reading") did not appear correlated with mathematical ability. Rather, it required a unique ability to understand the minds and intentions of others (variously called "theory of mind" or empathy). His study is far too complicated to explain in more detail here.

Researchers at NYU demonstrated the behavioral (and some neural) consequences of loss aversion in an investment-type task. Interestingly, the NYU researchers asked subjects to view all their upcoming "investments" in terms of a portfolio to see if it reduced their loss aversion (it did, but not entirely). They also found that an individual's level of loss aversion correlated with a greater SCR response (arousal) to losses versus gains.

Researchers from the Soochow and National Yang-Ming Universities of Taiwan, in the Soochow Gambling Task, have continued to demonstrate that people prefer small high frequency gains punctuated by occasional large losses (negative overall expected value) to small losses that are occasionally punctuated by a large gain (positive ooverall expected value), even after they are told the odds and probabilities. See my book for more detail about this remarkable result.

Brian Knutson's group at Stanford found that priming subjects with a sexy photograph increased NAcc activation (in the reward system) and increased their willingess to take risky financial gambles, even though finance has nothing to do with seeing a sexy photo (I presume).

In a study at NYU using one of Paul Glimcher's tasks, adolescents were found to be more "ambiguity seeking" than adults, but more "risk-averse" than adults when they knew the odds of the gamble. Per the researchers, perhaps their drive to learn and explore overcomes an aversion to known risks that they might not be skilled enough to handle yet.

In the second category of studies, Paul Zak's group at Claremont Graduate University found that touch (a massage of Player 2) more than tripled the amount that Player 2s (in the Trust Game) gave back to Player 1s. And the amount of $$ returned was correlated with blood oxytocin levels (especially baseline level). Recall that in the Trust Game, Player 2 isn't obligated to give anything back to Player 1, so this is a pretty profound finding. The Trust Game is described in my book in some detail.

In the third caegory, studies on how people make decisions differently, it is clear that there are observable patterns of brain activation, circuitry, underlying personality styles, and patterns of behavior such as:
1) Intuitive versus reasoning problem-solving,
2) Those who succumb to regret aversion (avoiding organizing their finances, for example) versus those who plan for the future,
3) Impusive versus more deliberate decision makers,
4) Maximizing versus satisficing decision makers, and
5) Machiavellian (primarily self-interested) versus more cooperative decision makers.
The first four results (preliminary) were found by Scott Huettel at Duke University's Center for Neuroecnomic Studies.

Other researchers found that the ability to self-reduce one's level of fear (and one's physiological fear-resonse) was correlated with the thickness of a part of the brain (VMPFC) that inhibits the amygdala and appears to generate soothing thoughts. Also, thickness of the insular cortex correlated with an increased sensitivity to aversive (bad) outcomes.

One interesting mention was of prior studies indicating that one's score on a "Private Body Consciousness Scale" (one's degree of somatic preoccupation) correlates with an increased susceptibility to the placebo effect. Now if one supposes that marketing is in some way activating placebo-effect-type brain circuits (people feeling good about themselves for a product purchase or consuming a branded product, for example), then it might be true that brain activity predicting the placebo effect will also predict whether one believes that higher prices denote higher quality (and better taste). According to Hilke Plassmann at Caltech, they do. That is, people who scored highly on body consciousness, when they drank a wine they was priced higher (but identical) to a lower-priced wine, thought it tasted better (and this finding was correlated with specific neural activation).

Other researchers found that individuals' "risk-aversion" to financial gambles appears to have a broad brain ciruit which governs it and indicates a specific personality type.

I hope this laundry list of findings is interesting and useful for all who could not attend!