What is Behavioral Finance?

Behavioral finance is the integration of theories of psychology, especially behavioral science, into finance, and it is a new marginal subject. Behavioral finance is a popular marginal interdisciplinary subject in finance, which is of great significance to the innovation and development of traditional financial theory.

Behavioral Finance

(Finance branch)

Behavioral finance explains, researches, and predicts the development of financial markets from micro-individual behaviors and the psychological factors that generate such behaviors. This research perspective seeks to analyze the business philosophy and decision-making behavior characteristics of different market entities in different environments by analyzing the deviations and abnormalities of financial market entities in market behavior, and strives to establish a correct reflection of the actual decision-making behavior and market operation of market entities. Descriptive model of the situation.

Although behavioral finance attempts to dig deep into the mysteries behind the operation of financial markets, it is not systematic or thorough. Therefore, there are not many behavioral financial models that have been formed today. The focus of research is still on the qualitative description of market anomalies and cognitive biases. And historical observations, as well as identifying behavioral decision attributes that may have a systematic effect on financial market behavior. The reason may be like what John Bogle, the godfather of index funds, said: "After 55 years in this industry, I still don't know how to predict the psychology of investors."

It is worth pointing out that humans' understanding of the volatility laws of the stock market is a very challenging world-class problem. So far, no theory or method can be convincing and stand the test of time. In 2000, Robert Schiller, one of the founders of behavioral finance theory and a professor of economics at Yale University, wrote in "Irrational Prosperity". One book states: "We should keep in mind that stock market pricing has not formed a perfect science"; in 2013, the Royal Swedish Academy of Sciences awarded Robert Schiller and others the Nobel Prize in Economics for that year: there is almost no way to Accurately predict the direction of stock and bond markets in the next few days or weeks, but it may be possible to use research to predict prices for more than three years.

At present, the representative theories about the pricing of financial assets and the logic of stock market volatility include the following: Keynesian beauty theory,

As early as half a century ago, Edward introduced decision-making into the field of psychological research and outlined a blueprint for future research. But the theoretical research of cognitive psychology did not achieve a huge breakthrough until Carneman and Butchersky published their research results on the subject of judgment and decision-making. Before introducing Carneman's contribution, we will first introduce some essential differences between economics and psychology in terms of theoretical assumptions about decision making.

Behavioral finance is an interdiscipline of finance, psychology, behavior, and sociology

The challenge of behavioral finance to the two traditional assumptions provides us with a new perspective on the corporate governance of commercial banks.

Human behavior hypothesis

Traditional financial theory holds that people's decisions are based on

Traditional economics usually assumes that market behavior is driven by material motivation, and that economic decisions made by people are rational and the inevitable result of the pursuit of self-interest. Rationality here means that decision makers conduct a systematic analysis of all available information and make optimal decisions in the face of numerous choices. Decisions are also forward-looking, that is, decisions are based on careful weighing of all possible future consequences. In other words, traditional Western economics holds that economic behavior is determined by external incentives. Psychology, especially cognitive psychology, believes that individual decision makers are a complex system that can consciously and rationally identify and explain some available information. But at the same time, there are some factors that are difficult to be aware of, which systematically affect human behavior. In general, human behavior is determined by intrinsic motivation.

In the past 10 years, a new discipline-behavioral finance-has emerged in foreign capital markets. It is recognized that many phenomena and processes that occur in the capital market cannot be explained by existing methods and theories. For example, according to common sense, when the price drops, the risk is released, which is safer and more valuable. At this time, you should actively buy, but people will desperately sell.

Behavioral finance analyzes and explains certain changes in the capital market from the behavior and psychological characteristics of investors. For example, why do more people sell and fewer people buy when the stock price drops? This is because people have a herd mentality. Everyone always thinks that most people are right. Since most people have taken the action of selling, then he is willing to sell as an individual. This is a psychological characteristic inherent in humans and many animals. For another example, there is a common phenomenon in the investment world: when a stock rises, the holder is particularly willing to sell it for profit, but when the stock drops 10%, it is unwilling to sell. Behavioral finance research has found that this is because people have a psychological characteristic of loss aversion and are unwilling to accept the fact of loss. In this case, even if the investor knows that there are problems with the fundamentals of the company and is unwilling to sell, he will be lucky to "give up in the future" and use it to paralyze himself.

Behavioral finance is to study and explain the phenomenon of stock market changes based on human psychological and behavioral characteristics. The great thing about this doctrine is that it historically abandoned the thinking of stock market as an objective material.

Before the advent of behavioral finance, the stock market and buildings were considered to be the same objective thing. Investing in the stock market is the same as the principle of engineers designing buildings. As long as you understand the bearing capacity of the ground and materials, calculate the length, width, and height, and draw a map, you can build. As long as you strictly adhere to the data, construction is a high-quality building. Anatomical analysis and demonstration calculations can correctly invest.

Treating the stock market as dead, the results can no longer be studied, and many phenomena cannot be explained. Behavioral finance has historically acknowledged that the stock market is a living thing, and many of its changes and processes are determined by human psychology. This is exactly what behavioral finance is all about. It has opened up a correct direction to take human heart and human behavior as the most basic cause of changes in the stock market. It historically acknowledged that changes in the stock market in many cases were not purely objective, but related to the psychological and behavioral characteristics of participants. The stock market is largely a reflection of human nature, and many phenomena in the stock market do not conform to scientific principles and established logic.

Past theories have assumed that capital market participants are all computers, all of which are emotionally and super-rational, and that behavior follows the principle of interest. In fact, this is not the case. Every time the stock market plummets or the stock price plummets, "

As a booming emerging field, behavioral finance still has many shortcomings; in order to form an independent discipline in the field of modern finance, theoretical innovation and exploration must be carried out in the following main areas in the future.

In the booming process of this emerging field, financial scholars in China are likely to make greater contributions to the future exploration of behavioral finance.

1. Use latecomer advantages to seize key issues to make breakthroughs.

Since the real rapid development of behavioral finance is after the late 1980s, it has not yet established its new basic theoretical framework, a unique and unique analysis paradigm with strict internal logic, a core model based on behavior, a clear research object, and Research methods, clear research lines and unique knowledge points. It is entirely possible for financial scholars in China to take advantage of late development in the process of rapid development of this discipline, seize the opportunity of rapid development of new disciplines, and make breakthroughs in the above key issues.

2. The characteristics of China's transition economy and emerging financial markets provide an external environment for the rapid development of behavioral finance in China.

The current research of behavioral finance is mainly aimed at the mature financial markets in the United States. In China during the transition period, the market economy has just started, and the establishment of financial markets is far from mature. What is the formation of financial asset prices? The psychology of investors is What? What is the impact on the price of financial assets? Is it special? These questions have to be answered by scholars in China. At the beginning of the creation of the financial market, investors' speculative sentiment was strong, and the impact on financial asset prices was also obvious. It is a good laboratory for testing and developing behavioral financial theory. The test and development of behavioral finance in China's financial market can test the universality of behavioral finance theory and the specificity of space and institution span in time span.

3. Research on investor behavior in China is easier to achieve results.

Behavioral finance has created a new research field, which is the study of investor behavior. Traditional finance assumes that all rational people are homogeneous, so the behavior of investors has little effect on the price of financial assets and has no research significance. Direct testing of the validity of theoretical assumptions is not very common in economics, and may be influenced by Friedman's famous assertions (Friedman once pointed out that the evaluation of a theory should be based on the validity of its predictions Rather than the validity of the hypothesis), so there has been no effective research on the behavior of perpetrators for a long time. In behavioral finance, the psychology and behavior of investors affect the price of financial assets, so it is of great significance to study investor behavior. Research on investor behavior can more accurately grasp the behavior of the actor, and provide a basis for establishing axiomatic assumptions of the actor closer to reality. For example, Odean (1998) found that investors have a disposal effect through their personal account data, that is, investors are more likely to sell profitable stocks than to lose stocks. Various beliefs found in behavioral finance are more obvious to investors in China, and investor sentiment has a more significant impact on financial asset prices. Therefore, it is more important to study the behavior of Chinese investors, and it is easier to obtain results.

Behavioral finance is a discipline with a very close combination of theory, practice and technology. The close combination and interaction of theoretical research and practical operation plays an important role in the development and improvement of the discipline. Behavioral finance starts with the study of the behavior of actors in financial markets, so it is necessary to understand the behaviors and rules of actors in a deeper way, so that they can accurately grasp the impact of actors on financial asset prices and effectively explain financial markets phenomenon. This requires theoretical researchers to integrate more closely with practice. On the one hand, they apply theory to practice and accept the test of practice; on the other hand, they deepen their understanding of the market and cultivate research intuition in practice to further promote theoretical innovation. At the same time, participation in the practice of financial markets can provide a lot of rare first-hand data for the demonstration of behavioral finance, and promote the theoretical development of behavioral finance. Most of the masters in the field of behavioral finance have a close relationship with the market. For example, Thaler, a leader in this field, is one of the partners of Fuller & Thaler Asset Management Company. The management company is named after three behavioral finance experts Lakonishok, Shleifer, and Vishny. It applies behavioral finance theory to manage nearly 10 billion US dollars of financial assets; Robert J. Shiller and other behavioral finance experts also mostly Own your own asset management company. The participation of behavioral finance experts in financial markets is important for theoretical innovation, and it also promotes the improvement of research methods and techniques. The rapid development of behavioral finance in China should also be closely integrated with the practice of financial markets.

Since the 1980s, with the accumulation of various anomalies in the financial market and the increasing emphasis on the study of financial anomalies, standard financial theory has been severely challenged. A number of new financial theories that try to explain the actual behavior of financial markets have gradually become The rise of behavioral finance theory is one of them.

Research Status

Based on the research results of behavioral science, psychology, and sociology, behavioral finance has initially formed a theoretical system that takes the psychological factors of parties involved in financial activities as its basic characteristics. So far, researchers have summarized some psychological characteristics of investors' decision-making and general characteristics of their decision-making behaviors:

1.Psychological characteristics of investors

There are four main views on the psychological characteristics of investors: Overconfidence: Overestimating one's own judgment and overconfidence. Psychological research has found that when people say they are 90% sure about something, the probability of success is only about 70%. Loss-aversion:

China's securities market is an emerging market that has not yet matured in many aspects. At present, a prominent problem is excessive speculation, and the main reason for this is the irrational behavior of many small and medium investors. Investors in the securities market can be divided into institutional investors and ordinary investors. The former has advantages in capital strength, analytical methods and information acquisition and grasp; the latter, due to its weak power, often tries to figure out and inquire about the former's news or actions. Use it as a reference for your own decisions.

In China, small and medium investors account for the vast majority of investors. Their decision-making behavior largely determines the development of the market, and they appear as vulnerable people. The irrationality of their decision-making behavior has seriously caused the market Instability. Therefore, China's securities market cannot be correctly analyzed only with the help of modern finance methods. We should pay full attention to this emerging theoretical method of behavioral finance, use it to develop and improve modern finance, and apply it to China's securities market.

Choose a fund manager

Apply the research results of behavioral finance to the practice of China's securities market, and reasonably guide the behavior of investors. For the majority of small and medium investors, education should be used to rationalize them, and improve the investment decision-making ability of securities market investors and the efficiency of market operations. For institutional investors, it is necessary to improve their investment management level. For example, a prominent problem of open-end funds is the redemption of fund shares. Fund managers need to determine the liquidity of assets based on their estimates of the amount of redemption, and this inevitably requires the estimation of investors' behavioral decision-making methods. Investors tend to overestimate risk when they are under pressure. If there is a slight wind, they may redeem in large quantities, and herd mentality may deepen this trend and put the fund under greater pressure. In addition, due to investors' regret and prudence, they often use the agent system to transfer their responsibility for economic results and the pressure they receive. Through in-depth analysis of this, fund managers can determine reasonable management fee rates and improve fund operations. Level.

The development of the capital market and institutional investors has made investment funds gradually become the main investment institutions in the capital market. Investment institutions with mutual investment funds, pension funds, and hedge funds as the main investment institutions have become the most important investment entities in the market. The rise of the status of investment funds has also made investment funds gradually become important investment targets for resident investors. Therefore, how to determine the investment targets among many investment funds has become the subject of many scholars' research. The investment fund manager is the management of the investment fund and is the determiner and implementer of the fund's investment strategy. The choice of investment funds is largely the choice of fund managers. The professional knowledge and psychological quality of fund managers have also become important considerations when choosing a fund. The choice of fund managers was mainly guided by the traditional efficient market theory and information theory, but with the development of financial theory, behavioral finance theory has become more and more important in this field.

According to the theory of behavioral finance and the reality of China, Chinese investors must consider the behavioral finance theory in addition to the considerations in traditional financial theory when determining investment objects and selecting fund managers.

First, an excellent fund manager should have a strong professional academic foundation and a wealth of financial professional theory and practical knowledge. A formal education and knowledgeable manager has a relatively strong ability to collect and analyze market information and to judge the situation of the market, which is more obvious in developed countries. The fourth issue of BusinessWeek in July 1994 published a survey result: most of the funds in the United States were classified according to whether the same position of the manager in the fund is an Ivy League graduate, and it was found that the fund was graduated by the Ivy League school as the manager 40 basis points higher than other funds. University of Chicago scholar Judith Chevaliert and MIT scholar Glenn Ellison took a sample of 492 fund managers (limited to growth and income funds) in the United States from 1988 to 1994 and analyzed them. The research shows that they have an MBA degree or have SAT scores as a student. Outstanding fund managers, the performance of funds under their management is significantly better than those managed by fund managers who do not have an MBA degree and ordinary SAT scores. The differences in fund performance caused by differences in fund managers' graduation school, academic performance, years of employment and other factors actually reflect the differences in manager's financial expertise, business experience, ability to use social networking, ability to collect and process market information, and so are investments. Factors that investors should consider when choosing a fund manager (JudithchevalierandGlennEllison, 1999).

Secondly, an excellent fund manager should not only have good information collection and information analysis and processing capabilities, but also understand what kind of psychological and behavioral deviations investors and themselves will have in the market; an excellent fund manager should be able to avoid Factors cause major mistakes and understand the impact of investors' psychological deviations and decision errors on the market, and adopt corresponding investment strategies. For example, according to the theory of behavioral finance, investment entities in the market may be slow to respond to information in the market. After the good news causes a certain securities price to rise, this rising trend may continue for a certain period of time. Therefore, the Momentum Strategies for securities where the purchase price starts to rise and securities whose price begins to fall has become the investment strategy that investment funds can choose from. At this time, the fund manager must have a deep understanding and accurate grasp of the investor's psychology, the nature and extent of the impact on the market's delayed response, and the trend and duration of securities price changes in order to buy and sell securities at the right time. At this time, the research and grasp of the investing public psychology has become an important ability necessary for an excellent investment fund manager.

Thirdly, from the perspective of public investors, when choosing an investment fund to determine its own investment portfolio, the influence and deviation of the fund manager on the expected risk and return must be considered. For example, as mentioned earlier, the fund manager may overestimate his ability due to overconfidence. At this time, the fund manager may engage in riskier investments in order to obtain higher investment returns (DeLongJ. Bradford, AndreiShleifer, LawrenceH. SummersandRobertJ Waldmann, 1991). Also, for a period of time, fund managers with excellent investment performance may adopt more stable investment strategies than before to reduce the risk of the fund's investment portfolio in order to maintain their reputation and thereby lock in the investment income of the fund. Therefore, investors must pay attention to the psychological changes and behavioral tendencies of managers when selecting funds to avoid unexpected changes in the risk and return of the selected investment portfolio.

Finally, investors must also be aware that the psychological motivation of fund managers to improve their own interests may intentionally distort their image in the eyes of investors. For example, fund managers will adjust their investment positions near the disclosure date of investment funds to improve the public image of funds and managers in the market. Studies show that many investment institutions have less buying risk in the fourth quarter or the year-end. The tendency of securities with rising prices and positive returns to sell securities with higher risks, falling prices in the previous period, and negative returns (Josef Lakonishoketal, 1991). Therefore, investors need to consider the validity and authenticity of fund information and data when choosing a fund manager.

Implications for investors

(I) Behavioral Finance Investment Strategy

The behavioral deviation caused by the irrationality of market participants has led to the deviation of market prices, and if this deviation can be used reasonably, it will bring excess returns to investors. This formed the investment strategy of behavioral finance. Traditional investment strategies also include changes in the ability of investors to collect information and process information, and the characteristics of human psychological decision-making are gradually formed during a long-term evolution process, so certain behaviors are stable and cross-cultural, and behavioral financial investment concepts of trading strategies Correspondingly it is more durable. From the perspective of foreign countries, the behavioral finance investment strategies of the basic market vision are mainly valuable investment strategies and reverse investment strategies: momentum trading strategies, cost averaging strategies, time diversification strategies, and so on. In recent years, securities investment funds based on basic behavioral finance theory have appeared in mutual funds in the United States, such as Fuller-Thaler Asset Management Company initiated by Richard Thaler, a master of behavioral finance. Some of them have also made good investments with a compound yield of 25% Performance.

(2) Enlightenment for Chinese institutional investors

Behavioral finance plays an important role in guiding the development of China's open-end funds. An outstanding problem of open-end funds is the redemption of fund shares. Fund managers must determine the liquidity of assets based on their estimates of the amount of redemption, and this inevitably requires the estimation of investors' behavioral decision-making methods. Investors tend to overestimate risk when they are under pressure. If there is a slight wind, they may redeem in large quantities, and herd mentality may deepen this trend and put the fund under greater pressure. In addition, due to investors' regret and prudence, they often use the agent system to transfer their responsibility for economic results and the pressure they receive. Through in-depth analysis of this, fund managers can determine reasonable management fee rates and improve fund operations. Level.

Institutional investors should have become leaders in China's investment philosophy and investment strategies, but various types of funds have always been ambiguous in investment style. It can consider the use of behavioral financial interpretation of market phenomena, and adopt corresponding investment strategies based on the characteristics of China's securities market.

1. Reverse investment strategy and value investment strategy

The strategy is to buy stocks that performed poorly in the past and sell stocks that performed well in the past. Such as selecting stocks with low price-earnings ratios. Select stocks with a low market value to book value ratio and stocks with low historical returns. Behavioral economics believes that the reverse investment strategy is a correction to the stock market response and a simple extrapolation method.

China's stock market is known as the "policy market", and different investors respond to policies differently. Ordinary investors often show overreaction to policy information due to incomplete information, especially individual investors' response to policy news is particularly strong. The institutional investor's information base and expert team can have a certain foresight in grasping the policy. According to the behavioral response model of individual investors, they can adopt reverse investment strategies and carry out positive wave operations. China's stock market still has a lot of herding behaviors. Systematic deviations in forecasts for the entire market. This leads to the deviation of the stock price, and as investors actively follow the price trend, the deviation of the price from the underlying value of the stock is further amplified. These overvaluation or undervaluation of the value of the stock will eventually fall or rise as the value of the financial market returns, which will bring corresponding value investment opportunities.

The stock price of ST shares tends to rise rather than fall after the news of special handling or special transfer is announced. From the perspective of current finance. Due to the scarcity of shell resources in China's securities market, this type of announcement effect not only brings the company into a serious dilemma, but also that the company may become a potential M & A target, followed by major actions such as asset reorganization, giving Investors bring expectations of the value of their future revenue streams. Such stocks can also be part of the portfolio of institutional investors.

2.Momentum trading strategy

The core content of this strategy is to seek the continuity of stock price changes over a certain period. If the stock price changes continuously rises, a continuous selling strategy is adopted; if the stock price changes continuously decreases, a continuous buying strategy is adopted.

The disposition effect of Chinese investors is more serious than the findings of similar studies abroad. According to empirical studies by Zhao Xuejun and Wang Yonghong (1998-2000), it is found that the probability of investors selling winners in China's stock market is twice the probability of selling losers. In the study of Odean (1998), investors in foreign securities markets The probability of selling winners is 1.5 times the probability of selling losers. The disposal effect will bring the difference between the basic value of the stock and the market value, and the final convergence of this difference means that those stocks with a large amount of asset gains that are not realized are generally higher than those with a large amount of asset losses that are not realized. Expected return. This vision can be used to use momentum trading strategy, that is, based on past stock price movements, profit through margin.

In addition, due to the anchoring effect brought by investors' overconfidence, etc., they will also be insufficient to respond to new information, so that the stock's uptrend or downtrend will be maintained for a period of time. Therefore, momentum trading strategies can also be used for this purpose. Opportunities for profit are captured in this relationship between changes and ex post stock prices.

3. Technical analysis strategy

The sudden set of information brought by the typical herd behavior of Chinese investors also enhances the effectiveness of technical analysis. Think of graphic analysis as a kind of information for short-term decision making. When more and more investors use this main method, Suddenly set this analysis on this "information" and draw similar conclusions, and trade accordingly. At this time, investors will profit from it, and then attract more investors to use graphical analysis methods, and finally make the predicted value predicted by technical analysis and the future asset price do show a positive correlation.

Modern Portfolio Theory (MPT)

In 1952, American economist Harry M. Markowit applied the two mathematical concepts of the mean and variance of portfolio returns for the first time in his academic paper "Asset Selection: Effective Diversification" to make it mathematically clear. It defines investor preferences and explains the principle of investment decentralization in a mathematical way. It systematically illustrates the problem of asset portfolio and selection, marking the beginning of Modern Portfolio Theory (MPT).

Efficient Market Hypothesis (EMH)

In 1965, Eugene Fama, a professor of finance at the University of Chicago, published a paper entitled "Price Behavior in the Stock Market", deepened the theory in 1970, and proposed the efficient market hypothesis ( Efficient Markets Hypothesis (EMH). The efficient market hypothesis has a questioned premise that investors participating in the market are rational and able to respond quickly and reasonably to all market information. The theory holds that in a stock market with sound laws, good functions, high transparency, and sufficient competition, all valuable information has been timely, accurately, and fully reflected in the stock price trend, including the current and future value of the enterprise, unless there is a market Manipulation, otherwise it is impossible for investors to obtain excess profits higher than the market average by analyzing past prices.

Behavioral Finance (BF)

In 1979, Daniel Kahneman, a professor of psychology at Princeton University, and others published an article entitled "Expectation Theory: Decision Analysis in a State of Risk", establishing a psychological theory of the human risk decision process. Become a milestone in the history of behavioral finance.

Behavioral Finance (BF) is a comprehensive theory that organically combines finance, psychology, and anthropology, and tries to reveal the irrational behavior and decision rules of financial markets. The theory holds that stock prices are not only determined by the intrinsic value of the enterprise, but are also largely affected by the behavior of investors, that is, investor psychology and behavior have a significant impact on the price decision and changes in the securities market. It is a theory corresponding to the efficient market hypothesis, and its main content can be divided into two parts: arbitrage limitation and psychology.

It can be roughly considered that by 1980, the building of the classic investment theory had been basically completed. After that, scholars from all over the world have only done some repairs and improvements. For example, further research on the factors that affect the rate of return on securities, empirical and theoretical analysis of "different phases" in various markets, modification of assumptions about option pricing, and so on.