Tag: Behavioral Finance

Must-read: Roger Farmer: “Please: Lets Agree to Speak the Same Language”

Posted on by Brad DeLong

Must-Read: I want to plump for “self-fulfilling prophecies” or “multiple near-rational equilibria” myself:

Roger Farmer: Please: Lets Agree to Speak the Same Language: “Animal spirits, confidence, sunspots, self-fulfilling prophecies and sentiments…

…have all been used to mean shifts in markets caused by factors that are non-fundamental. Now Olivier adds herding as one more term…. The idea that non fundamental factors can have real effects was developed at the University of Pennsylvania in the 1980s at about the same time that the Real Business Cycle model took off…. The RBC agenda pulled ahead and stayed ahead for thirty years. That is now changing. Why this divergence?…

There were three major reasons why the RBC program pulled ahead. 1) there was no single strong individual to promote the sunspot agenda and the three initial leaders, Costas Azariadis, Dave Cass and Karl Shell could not even agree among themselves…. 2) The literature on sunspots was technically demanding…. 3) Cass, Shell and Azariadis were not interested in empiricism and they did not make an effort to promote their agenda at central banks or at applied groups such as the National Bureau of Economic Research…. If you are a graduate student or a researcher who is working, or planning to work, in this area, I have a plea. Can we at least agree to add no more words to refer to the same idea? Please: Lets agree to speak the same language and, in so doing, give credit to those who laid the foundations for this agenda.

Must-read: Olivier Blanchard: “The Price of Oil, China, and Stock Market Herding”

Posted on by Brad DeLong

Must-Read: Olivier Blanchard: The Price of Oil, China, and Stock Market Herding: “The main effect of a slowdown in China would be, through lower commodity prices…

…help rather than hurt the United States…. The oil price explanation… is even more puzzling…. It was taken for granted that a decrease in the price of oil was good news for oil-importing countries…. We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices…. [Not] convincing… [is] that very low prices lead to such serious problems for oil producers that this will end up… dominating the scene… [or] that the low prices reflect a yet unmeasured decrease in world growth…. Maybe we should not believe the market commentaries. Maybe it was neither oil nor China….

I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell…. So how much should we worry? This is where economics… gives the dreaded two-handed answer. If it becomes clear… that fundamentals are in fact not so bad, stock prices will recover…. [But] the stock market slump… can become self-fulfilling…. Hope for the first… worry about the second.

Must-Read: Joshua M Brown: The Woes of the Asset Managers

Posted on by Brad DeLong

Must-Read: Passive diversified portfolios with an eye toward overweighting factors that have historically offered high returns is what nearly all investors should be doing.

Joshua M Brown: The Woes of the Asset Managers: “I would say that the pressure on fees and the transparency around what you pay vs what you get makes most of the sector uninvestable…

…Multi-million dollar ad budgets and the typical PR campaigns are failing to counter the power of the internet. The jig is up; investors have gotten too savvy (or skeptical, either way) for these businesses to bounce back as they used to…. Last week I sat with someone from Goldman Sachs who showed me what they’re doing within Smart Beta ETFs and it looks just like what everyone else is doing–multi-factor passive portfolios emphasizing value, small, quality and momentum. The difference is, Goldman is charging 9 basis points (9!). I had to be picked up off the floor. Goldman is going slash-and-burn for factor investing market share with a pricing structure that rivals what State Street, Schwab, Vanguard and BlackRock are charging for plain-vanilla index exposure…. I’m not sure how Smart Beta ETFs (or active managers mimicking these styles) will be able to hold the line on charging more than 50 basis points in a world where Goldman gives it away for free…

Must-Read: John Authers: Number-Crunchers Lift Lid on Investor Choice

Posted on by Brad DeLong

Must-Read: This is what Akerlof and Shiller’s Phishing for Phools is about…

John Authers: Number-Crunchers Lift Lid on Investor Choice: “Retail investors…fatally drawn to chasing performance…

…buying high, selling low… heighten[ing] the peaks and lower[ing] the troughs…. In aggregate, all the money attracted by funds in that era went to funds that could show the strongest ratings (which are largely a function of performance)…. Past performance does not predict future performance. But it utterly controls what the consumer will ultimately buy….

Given a choice between two otherwise identical funds, Americans will take the cheaper one. Europeans will not…. In the US, investment advisers tend to be paid by fee, rather than commission, and have no incentive to advise otherwise…. But Americans are not as smart as all that. High turnover… is a bad idea…. Yet funds with a high turnover in the US tend to attract more than 0.5 per cent more in inflows each month…. Most counter-intuitively, and alarmingly… older than average funds… suffer outflows at a rate of 2.77 per cent of their assets each month….

Ultimately, funds are sold the same way as other branded goods. Marketers spot where the demand is moving, and launch something new that can be hyped. All the interest and selling action focuses on recent launches, while older products are gradually neglected, and watch money ebb out over time. It is not a great way to allocate capital…