Beyond greed and fear hersh shefrin pdf free download

All too many investors are unaware of the mental pitfalls that await them. Even once we are aware of our biases, we must recognise that knowledge does not equal behaviour. The solution lies is designing and adopting an investment process that is at least partially robust to behavioural decision-making errors. This book is unique in combining insights from the field of applied psychology with a through understanding of the investment problem.

The content is practitioner focused throughout and will be essential reading for any investment professional looking to improve their investing behaviour to maximise returns.

Key features include: The only book to cover the applications of behavioural finance An executive summary for every chapter with key points highlighted at the chapter start Information on the key behavioural biases of professional investors, including The seven sins of fund management, Investment myth busting, and The Tao of investing Practical examples showing how using a psychologically inspired model can improve on standard, common practice valuation tools Written by an internationally renowned expert in the field of behavioural finance.

Amoral, cunning, ruthless, and instructive, this multi-million-copy New York Times bestseller is the definitive manual for anyone interested in gaining, observing, or defending against ultimate control — from the author of The Laws of Human Nature. Every law, though, has one thing in common: an interest in total domination.

In a bold and arresting two-color package, The 48 Laws of Power is ideal whether your aim is conquest, self-defense, or simply to understand the rules of the game. Skip to content. Beyond Greed and Fear. Beyond Greed and Fear Book Review:. Author : Greg L. Bazaars Conversations and Freedom. Bazaars Conversations and Freedom Book Review:. The Psychology of Investing. The Psychology of Investing Book Review:.

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These cookies do not store any personal information. This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. This is how security analysts react to earnings announcements: They do not revise their earnings estimates enough to reflect the new information. Consequently, positive earnings surprises tend to be followed by more positive earnings surprises, and negative surprises by more negative surprises.

Of course, the unexpected surprises in store for analysts are also a manifestation of overconfidence because overly narrow confidence bands mean people get surprised more frequently than they anticipate. When I pose this question in MBA classes, about 40 percent of the students say they would take the gamble.

Now consider this variation. Imagine the bag contains colored chips that are either red or black, but the proportions are unknown. This phenomenon is known as the aversion to ambiguity. People prefer the familiar to the unfamiliar.

Remember the Wall Street proverb about greed and fear? I note that the emotional aspect of aversion to ambiguity is fear of the unknown. The case of Long-Term Capital Management, discussed in chapter 1, provides an apt example of this phenomenon. The Federal Reserve Bank of New York orchestrated this plan because of a concern that the failure of LTCM might cause a collapse in the global financial system.

The November 16, , issue of the Wall Street Journal describes the scene as the participants departed the meeting at which the deal was struck. The article attributes an interesting remark to Herbert Allison, then president of Merrill Lynch, a remark that typifies aversion to ambiguity as fear of the unknown. As they filed out, they were left to ponder whether all this was necessary, and whether a collapse would really have jolted the global financial system.

It was a very large unknown, Merrill's Mr. Allison says. It wasn't worth a jump into the abyss to find out how deep it was. But in describing ambiguity to aversion in terms of fear of the unknown, I suggest that some phenomena involve a combination of cognition and emotion.

Of course, both involve mental processes, and may be physiologically linked, as opposed to being separate from each other. Scholars have produced ample evidence that emotion plays an important role in the way people remember events. So, phenomena involving the availability heuristic may reflect both cognitive and emotional elements.

Here is an example. In , the Dow closed at In it closed at , just 27 points higher than the value achieved a decade earlier. In between, it gyrated wildly, recording four years of negative growth. During this period, inflation reduced the purchasing power of a dollar by over 66 percent. All Rights Reserved were terrified by that crash, says Mr. Fuller, the money manager. That's a very low probability event. But many of the people in this business have spent the last 20 years worrying about that happening again.

Throughout the book, readers will encounter many instances of representativeness, anchoring-and-adjustment, overconfidence, availability bias, and aversion to ambiguity.

These heuristics surface in many different contexts, such as analysts' earnings forecasts, investors' evaluation of mutual fund performance, corporate takeover decisions, and the Because of their reliance on heuristics, practitioners hold biased beliefs that render them vulnerable to committing errors.

In addition to the heuristics described in this chapter, readers will come across a host of others, such as excessive optimism, the illusion of validity, hindsight bias, the illusion of control, and self-attribution error. There are many examples of such errors in this book.

Chapter 3 Frame Dependence: The Second Theme show abstracts and keywords Hersh Shefrin This chapter discusses the following: loss aversion, loss realization, and losing projects mental accounting, frame dependence, and facing risk hedonic editing and tolerance for risk self-control and dividends regret and pension fund allocation money illusion and inflation Frame independence lies at the heart of the Modigliani-Miller approach to corporate finance.

Merton Miller has a succinct description of frame independence. When asked to explain, in twenty-five words or less, the essence of his contributions with Franco Modigliani, he said: If you transfer a dollar from your right pocket to your left pocket, you are no wealthier. Franco and I proved that rigorously. The form used to describe a decision problem is called its frame. When I speak of frame independence, I mean that form is irrelevant to behavior.

Proponents of traditional finance assume that framing is transparent. This means that practitioners can see through all the different ways cash flows might be described. Yet many frames are not transparent but rather are opaque. When a person has difficulty seeing through an opaque frame, his decisions typically depend on the particular frame he uses.

Consequently, a difference in form is also a difference in substance. Behavior reflects frame dependence. All Rights Reserved Loss Aversion In their landmark work on prospect theory, a descriptive framework for the way people make choices in the face of risk and uncertainty, Daniel Kahneman and Amos Tversky provide evidence of frame dependence.

The starting point in their work is the role of loss, an issue explored by Harry Markowitz b. Kahneman and Tversky studied how people respond to the prospect of a loss.

Here is one of their examples. Would you choose to take the guaranteed loss or take a chance? Most people opt for the latter. Because they hate to lose! And the uncertain choice holds out the hope they won't have to lose. Kahneman and Tversky call this phenomenon loss aversion.

They find that a loss has about two and a half times the impact of a gain of the same magnitude. In a manual for stockbrokers, Leroy Gross describes the difficulties investors face in coming to terms with losses. Many clients, however, will not sell anything at a loss. They don't want to give up the hope of making money on a particular investment, or perhaps they want to get even before they get out. The get-evenitis disease has probably wrought more destruction on investment portfolios than anything else Investors who accept losses can no longer prattle to their loved ones, Honey, it's only a paper loss.

Just wait. It will come back. Take the case of Nicholas Leeson. In , Leeson became famous for having caused the collapse of his employer, year-old Barings PLC. In , Leeson began to engage in rogue trading in order to hide errors made by his subordinates. Eventually, he incurred losses of his own, and get-evenitis set in. He asserts that he gambled on the stock market to reverse his mistakes and save the bank. For example, 3Com's popular Palm Computing products, the handheld organizers that access data with a stylus, had a predecessorApple Computer's more sophisticated Newton.

He coined the term personal digital assistant to describe the concept and argued that it would be a pivotal step in the convergence of three industries: computing, communications, and entertainment. Moreover, because of initial failures in its handwriting recognition capability, cartoonist Gary Trudeau lampooned the Newton in his comic strip Doonesbury. Given the size and demographics of Gary Trudeau's readership, think about the impact the availability heuristic had on Newton's potential market.

By January , it was apparent that sales were disappointing and the Newton was a losing project. But Apple did not terminate it. The company was committed to personal digital assistants. A year later, in January , Apple had added enhanced features, and the year after that it came out with a backlit screen, but to no avail. In March Apple Through all this, the Newton remained a loser.

CEOs may come and go, but losing projects stay on. John Sculley went; he was replaced by Gil Amelio, who also came and went. Years before, Sculley had ousted Jobs.

In January , about ten years after its inception, CEO Jobs announced his decision to terminate the Newton project. Concurrent Decisions Here is another Kahneman-Tversky decision problem: Imagine that you face the following pair of concurrent decisions. First examine both sets of choices, then indicate the option you prefer for each.

First decision: Choose A. Second decision: Choose C. The way that people respond to this problem tells us a lot about their approach to making decisions. Consider your own responses.

Choosing A in the first decision would be the risk-averse choice. Did you recognize the second decision? We encountered it before, in the previous section. Did you respond the same way as before? In my own experience, about 90 percent choose D in the second decision problem.

They want the chance to get even. The two decision problems together constitute a concurrent package. But most people do not to see the package. They separate the choices into mental accounts.

And that brings us to frame dependence. Suppose you face a choice. Which choice would you make? A no-brainer, right? It should be: This decision frame is transparent. But sometimes the frame is opaque. Consider the decision problem at the beginning of this section. However, But most people don't see through the opaque frame. The opaque frame makes for a brainer instead of a no-brainer. Hedonic Editing In his stockbroker manual, Gross implicitly raises the issue of frame dependence within the context of realizing a loss.

His essential point is that investors prefer some frames to others, a principle known as hedonic editing. Consider Gross's advice to stockbrokers: When you suggest that the client close at a loss a transaction that you originally recommended and invest the proceeds in another position you are currently recommending, a real act of faith has to take place. That end p.

All Rights Reserved act of faith can more easily be effected if you make use of some transitional words that I call magic selling words. The words that I consider to have magical power in the sense that they make for a more easy acceptance of the loss are these: Transfer your assets. Because they induce the client to use a frame in which he or she reallocates assets from one mental account to another, rather than closing a mental account at a loss.

Thaler and Eric Johnson propose a theory of hedonic editing for mental accounts. As part of a study, they administered a series of choice problems to subjects. You will find two of these problems below. Read the first problem, record your answer, and then move on to the next problem. Imagine that you face the following choice. The outcome of the stylized lottery is determined by the toss of a fair coin.

Would you choose to participate in the lottery? Yes or no? Yes means you take your chances with the coin toss. Would you accept the guaranteed loss? No means you take your chance with the coin toss. Let's consider how people usually respond to these questions.

However in the second choice problem, many people choose the lottery over the guaranteed loss. There is a lesson here: People are not uniform in their tolerance for risk. It depends on the situation. Some appear to tolerate risk more readily when they face the prospect of a loss than when they do not. All Rights Reserved It is common for financial planners and investment advisers to administer risk tolerance quizzes in order to determine a degree of risk that is suitable for their clients.

However behavioral finance stresses that tolerance for risk is not uni-dimensional. Rather it depends on several factors, one being recent experience facing risk. Here are two more examples developed by Thaler and Johnson that bring out the complexity of these issues. The outcome of the second lottery is determined by the toss of a fair coin.

Would you choose to participate in the second lottery after having won the first? Would you choose to participate in the second lottery after having lost in the first?

Now that you have recorded your yes or no answers, compare your response to choice 3 with your response to choice 1. From a dollar perspective, choices 1 and 3 are equivalent. In the framework of traditional finance, people should respond the same to both. Yet in practice, many switch their choices. When replicating the Thaler-Johnson study I have found that about 25 percent of the respondents are more willing to take the gamble in choice problem 3 than they are in the dollar-equivalent choice problem 1.

Thaler and Johnson suggest that the answer involves hedonic editing, the way people organize their mental accounts. But if they win, they do not net their two gains; instead, they savor them separately. According to Thaler and Johnson, the added attraction of experiencing gains separately inclines people to be more willing to gamble.

Thaler and Johnson suggest an end p. All Rights Reserved explanation based on the way people experience losses. They note that people seem incapable of netting out moderately sized losses of similar magnitudes. The added pain leads people to shy away from taking the gamble as framed in choice problem 4, relative to the frame in choice problem 2. Cognitive and Emotional Aspects People who exhibit frame dependence do so for both cognitive and emotional reasons.

The cognitive aspects concern the way people organize their information, while the emotional aspects deal with the way people feel as they register the information. The distinction between cognitive and emotional aspects is important. Thaler and Johnson call this a house money effect. Hedonic editing means they prefer some frames to others. That is the main insight to be gleaned from studying how people chose in the four preceding choices.

In a financial context, hedonic editing offers some insight into investors' preference for cash dividends. When stock prices go up, dividends can be savored separately from capital gains. When stock prices go down, dividends serve as a silver lining to buffer a capital loss. Remember Merton Miller's succinct description of frame independence? Some investors prefer to keep dividends in their right pocket. The following excerpt, taken from a Forbes magazine interview with closed-end fund manager Martin Zweig, describes how he came to realize the importance of dividends.

It began with the fact that his fund was trading at a deep discount relative to net asset value. NAV , the value the shares would trade for if the fund were open-ended instead of being closed. All Rights Reserved Then in we did a closed-end fund I always worried about discounts on closed-end funds The first nine months out of the gate, we were at a 17 percent discount. I was mortified. I sat down and did a lot of thinking.

Bond funds at the time were selling at about parity. Stock funds were all at discounts. It didn't make sense, because stocks do better than bonds in the long run. And I realized bond funds pay interest.

People like the certainty of an income stream. So I said, Well, we're going to pay the dividend, whether we earn it or not. And we went to this 10 percent dividend policy The discount narrowed immediately. Brimelow, Self-Control. Self-control means controlling emotions. Some investors value dividends for self-control reasons as well as for reasons that stem from hedonic editing.

Martin Zweig talks about paying a dividend whether earned or not because people like the certainty of an income stream. What does a reliable dividend have to do with self-control? Meir Statman and I Shefrin and Statman argue that the answer involves the don't dip into capital heuristic. Older investors, especially retirees who finance their living expenditures from their portfolios, worry about spending their wealth too quickly, thereby outliving their assets.

They fear a loss of self-control, where the urge for immediate gratification leads them to go on a spending binge. Therefore, they put rules into place to guard against the temptation to overspend. Don't dip into capital is akin to don't kill the goose that lays the golden eggs. But if you don't dip into capital, how do you finance consumer expendituresSocial Security and pension checks alone?

Not necessarilythis is where dividends come in. Dividends are labeled as income, not capital. And investors tend to frame dividends as income, not capital. Again, this is frame dependence. Investors feel quite comfortable choosing a portfolio of stocks that feature high dividend payouts and spending those dividends. Regret Imagine someone who makes a decision that turned out badly and engages in self-recrimination for not having done the right thing.

Regret is the emotion experienced for not having made the right decision. Regret is more than the pain of loss. It is the pain associated with feeling responsible for the loss. One day, for the sake of variety, she decides to try a different route. That particular day she winds up in an accident. Now, even if the odds of an accident were no different on the two routes, how will that person feel?

Will she chastise herself, thinking If only I had done what I always do and taken my regular route! If so, she is experiencing the frustration of regret.

Regret can affect the decisions people make. Someone who feels regret intensely, does not have a strong preference for variety, and thinks ahead, may follow the same route to work every day, in order to minimize possible future regret. Here is a financial example. Consider the choice of equity-fixed income allocation in a defined contribution retirement plan. In the January issue of Money magazine, Harry Markowitz explains what motivated his personal choice about allocation.

As the Nobel laureate recognized for having developed modern portfolio theory, was he seeking the optimum trade-off of risk and return? Not exactly. He said, My intention was to minimize my future regret. So I split my contributions fifty-fifty between bonds and equities Zweig , In other words, had Harry Markowitz selected a percent equity allocation, and had stocks subsequently done terribly, it would have been to easy, in hindsight, to imagine having selected a more conservative postureand this would give rise to considerable self-recrimination, meaning regret.

Regret minimization also leads some investors to use dividends, instead of selling stock, to finance consumer expenditures. Those who sell stock to finance a purchase, only to find that shortly thereafter the stock price soars, are liable to feel considerable regret.

That is often at the heart of expressions such as this is my half-million-dollar car. Money Illusion Frame dependence also impacts the way that people deal with inflation, both cognitively and emotionally. This is the issue of money illusion.

Consider two individuals, Ann and Barbara, who graduated from the same college a year apart. Upon graduation, both took similar jobs with publishing firms.

Barbara also end p. As they entered their second year on the job, who was doing better in economic terms, Ann or Barbara?

As they entered their second year on the job, who do you think was happier, Ann or Barbara? As they entered their second year on the job, each received a job offer from another Who do you think was more likely to leave her present position for another job, Ann or Barbara?

Most people indicate that Ann is better off, Barbara is happier, and Ann is more likely to look for another job. Now this is somewhat perplexing. If Ann is better off, why is she less happy and more likely to look for another position? Shafir, Diamond, and Tversky suggest that although people can figure out how to adjust for inflation, it is not a natural way for them to think.

The natural way is to think in terms of nominal values. Therefore people's emotional reaction is driven by the nominal values, and those appear more favorable for Barbara than they do for Ann. Summary This chapter presents the second theme of behavioral finance, frame dependence, which deals with the distinction between form and substance. Framing is about form. In short, frame dependence holds that differences in form may also be substantive.

It reflects a mix of cognitive and emotional elements. The cognitive issues pertain to the way that information is mentally organized, especially the coding of outcomes into gains and losses. There are several emotional issues, the most fundamental of which is that people tend to feel losses much more acutely than they feel gains of comparable magnitude. This phenomenon has come to be known as loss aversion. Therefore, people prefer frames that obscure losses, if possibleand engage in hedonic editing.

People tend to experience losses even more acutely when they feel responsible for the decision that led to the loss; this sense of responsibility leads to regret.

Regret is an emotion. People who have difficulty controlling their emotions are said to lack self-control. Some people use framing effects constructively to help themselves deal with self-control difficulties. Chapter 4 Inefficient Markets: The Third Theme show abstracts and keywords Hersh Shefrin This chapter discusses the following: representativeness, and the market's treatment of past winners and losers anchoring-and-adjustment, and the market's reaction to earnings announcements loss aversion, and the risk premium on stocks sentiment, and market volatility overconfidence, and the attempt to exploit mispricing Cause and Effect One of the most fiercely debated questions in finance is whether the market is efficient or inefficient.

How did it advertise itself to investors? LTCM members promoted their firm as an exploiter of pricing anomalies in global markets. In this regard, consider the following heated exchange between Myron Scholes, LTCM partner and Nobel laureate, and Andrew Chow, vice president in charge of derivatives for potential investor Conseco Capital. Chow is quoted as saying to Scholes, I don't think there are that many pure anomalies that can occur; to which Scholes responded: As long as there continue to be people like you, we'll make money.

But Scholes is correct about cause and effectinvestors' errors are the cause of mispricing. Thanks to them, the supreme Vatican lost control over its Holy Roman Empire for the first time. Such heresies had responses too — the Apostolic Inquisition, Avignon Papacy, Mongol Invasions of Europe and the Middle East, and the extermination of non-compliant ruling European dynasties namely Hohenstaufen and Arpad.

Only the Bathorys survived, but they had to endure a debilitating war to do so. One dynasty — Habsburg — sought to profit from the chaos. Indeed they did. Their arrival marks the end of the first great pendulum swing of European cultural metamorphosis. This is a story of us. They already exist in our psyches, and they do their damage before we are aware of their presence. Every investor has weaknesses and vulnerabilities.

These make up the darker side of our investor identity. And though some are more at risk than others, these investor traps are universal human tendencies to which every investor is susceptible. Forging a more effective investor identity involves not only recognizing these traps, but also realizing your personal susceptibilities to them and developing the ability to sidestep them along the way to your goals.

This chapter describes the most common and insidious investor traps. You will learn to identify and minimize the impact of these common mental mistakes. The transformation of portfolio theory begins with the identification of anomalies. Gaps in perception and behavioral departures from rationality spur momentum, irrational exuberance, and speculative bubbles.

Behavioral accounting undermines the rational premises of mathematical finance. Whether hedging against intertemporal changes in their ability to bear risk or climbing a psychological hierarchy of needs, investors arrange their portfolios and financial affairs according to emotions and perceptions. Risk aversion and life-cycle theories of consumption provide possible solutions to the equity premium puzzle, an iconic financial mystery. Prospect theory has questioned the cogency of the efficient capital markets hypothesis.

Behavioral portfolio theory arises from a psychological account of security, potential, and aspiration. Inside, you will learn how ISAs and SIPPs can boost your returns, create a tax-free income for life and reduce the risk of running out of money during retirement. However, its economic growth has generated rising problems in inequality, alienation, and sustainability with the agrarian crises of the s giving rise to real social outcry to the extent that they became the object of central government policy reformulations.

Contributing to a paradigm-shift in the theory and practices of economic development, this book examines the concept of social economy in China and around the world. It offers to rethink space, economy and community in a trans-border context which moves us beyond both planned and market economies. The chapters address theoretical issues, critical reflections and case studies on the practice of social economy in the context of globalization and its attempt to create an alternative modernity.

Through this, the book builds a platform for further cross-disciplinary and cross-boundary dialogue on the future of social economy in China and the world.