Investor Behavior

H. KENT BAKER is University Professor of Finance at American University's Kogod School of Business in Washington, DC. As one of the most prolific finance academics, he has authored or edited 21 books and published more than 150 refereed articles. He has consulting and training experience with more than 100 organizations, serves on multiple editorial boards, and is the Past President of the Southern Finance Association. Professor Baker holds eight earned degrees including three doctorates as well as CFA and CMA designations. VICTOR RICCIARDI specializes in current trends in behavioral finance. As Assistant Professor of Financial Management at Goucher College in Baltimore, Maryland, he has made important contributions to understanding the psychology of investing. Professor Ricciardi also serves as Coordinator of Behavioral and Experimental Research for the Social Science Research Network (SSRN). He edits several SSRN eJournals related to behavioral finance, financial history, behavioral economics, risk-taking behavior, and behavioral accounting.

“Baker and Ricciardi have done an excellent job of soliciting articles that blend academic research with real-world applications that can be used by financial planners. Investor Behavior is an excellent book for anyone who wishes to detour from the beaten path of behavioral finance and to implement what has been learned about investor psychology to better understand traders and assist clients.” — Financial Analysts Journal

• Acknowledgments xvPart One Foundations of Investor BehaviorChapter 1 Investor Behavior: An Overview 3H. Kent Baker and Victor RicciardiIntroduction 3Organization of the Book 11Summary 20References 21About the Authors 23Chapter 2 Traditional and Behavioral Finance 25Lucy F. AckertIntroduction 25Traditional Finance 26Behavioral Finance 31Summary 39Discussion Questions 39References 39About the Author 41Chapter 3 Behavioral Economics, Thinking Processes, Decision-Making, and Investment Behavior 43Morris AltmanIntroduction 43Behavioral Economics, Heuristics, and Decision-Making 44Investment Heuristics and Investing in Financial Assets 45The Trust Heuristic and Decision-Making 48Other Critical Decision-Making Heuristics 49Rational Investor Decision-Making in a World of Complex Information 56Summary 58Discussion Questions 59References 59About the Author 61Part two Personal Finance IssuesChapter 4 Financial Literacy and Education 65Michael S. Finke and Sandra J. HustonIntroduction 65Examples of Financial Literacy Measures 68Financial Literacy and Behavior 71Financial Literacy Education 75Summary 77Discussion Questions 78References 78About the Authors 81Chapter 5 Household Investment Decisions 83Vicki L. BoganIntroduction 83Financial Market Participation 83Market Friction Effects on Household Investment Behavior 85The Effects of Behavioral Biases on Household Investment Behavior 87Summary 93Discussion Questions 94References 94About the Author 98Chapter 6 Personality Traits 99Lucia Fung and Robert B. DurandIntroduction 99A Structural Model of Personality 100Risk-Taking Behavior 103Overconfidence 104Personality and Gender 105Personality as a Guide for Investors 107Summary 108Discussion Questions 109References 109About the Authors 114Chapter 7 Demographic and Socioeconomic Factors of Investors 117James FarrellIntroduction 117Literature Review 118Case Study: The Florida Department of Education Employees 122Summary 131Discussion Questions 132References 133About the Author 134Chapter 8 The Effect of Religion on Financial and Investing Decisions 135Walid Mansour and Mouna JlassiIntroduction 135Religions and Economic Factors: Dependence or Bifurcation? 136Religion and Individual Investing Behavior 138Summary 147Discussion Questions 147References 147About the Authors 151Chapter 9 Money and Happiness: Implications for Investor Behavior 153Jing Jian XiaoIntroduction 153Can Money Buy Happiness? 154Can Happiness Buy Money? 162Implications for Investor Behavior 164Summary 165Discussion Questions 165References 166About the Author 169Chapter 10 Motivation and Satisfaction 171Lewis J. AltfestIntroduction 171Classical Economic Motivation 171Behavioral Economic Motivation 173Maslow’s Hierarchy of Needs 175Criticism of Maslow’s Hierarchy of Needs 177Higher Level Motivation 179Humanism 181Maslow and Investment Management 182Personal Finance Integration 183Summary 185Discussion Questions 186References 187About the Author 188Part Three Financial Planning ConceptsChapter 11 Policy-Based Financial Planning: Decision Rules for a Changing World 191Dave Yeske and Elissa BuieIntroduction 191Managing Behavioral Biases in the Financial Planning Engagement 194A Process for Developing Financial Planning Policies 195Applicability of Financial Planning Policies 199Policy-Based Financial Planning: The Strategic Perspective 201Example of Policies Derived through Stochastic Modeling 202Sample Case Applications 203Summary 205Discussion Questions 206References 206About the Authors 207Chapter 12 Financial Counseling and Coaching 209John E. Grable and Kristy L. ArchuletaIntroduction 209Financial Counseling: A Historical Perspective 210Theoretical Approaches: A Financial Counseling Perspective 215Financial Counseling in the Twenty-First Century 221Summary 223Discussion Questions 224References 225About the Authors 226Chapter 13 Financial Therapy: De-Biasing and Client Behaviors 227Joseph W. Goetz and Jerry E. GaleIntroduction 227What Is Financial Therapy? 229Brief History of Financial Therapy 231Theoretical Foundations for Financial Therapy 232The Practice of Financial Therapy 237Future Research and Practice 240Summary 240Discussion Questions 241References 241About the Authors 243Chapter 14 Transpersonal Economics 245Renée M. SnowIntroduction 245Historical and Spiritual Overview of Money 248The Western Eco/House 252An Alternative Perspective 254The Open Eco in Financial Planning 256Summary 260Discussion Questions 261References 261About the Author 264Chapter 15 Advising the Behavioral Investor: Lessons from the Real World 265Gregg S. FisherIntroduction 265Risk, Return, and the Investor: A Complex Relationship 266Investments with People Problems 269The Impact of Investor Behavior on Portfolios 272How Advisors Can Help the Behavioral Investor 275Turning Bias into Benefit: How to Profit from Investor Behavior 278Summary 281Discussion Questions 281References 282Disclosure 283About the Author 283Chapter 16 Retirement Planning: Contributions from the Field of Behavioral Finance and Economics 285James A. Howard and Rassoul YazdipourIntroduction 285A Life Cycle Financial Planning and Wealth Management Model 286Demographic and Macroeconomic Context 287Biases, Heuristics, and Framing Effects on Retirement Planning 288Hyperbolic Discounting 291The Role of the Brain in Financial Decision-Making 293Financial Decision-Making Quality and Age 295The Role of Self-Awareness and Self-Control 296Trust and Retirement Saving and Planning: The Basics 297Trust and Retirement Saving and Planning: The Decision 298Trust-Based Implications for Retirement Saving and Planning 299Discussion Questions 302References 303About the Authors 305Chapter 17 Knowing Your Numbers: A Scorecard Approach to Improved Medical and Financial Outcomes 307Talya Miron-Shatz and Stephanie GatiIntroduction 307The Need for Better Control of Chronic Diseases 309The Scorecard Approach 310Target Population and Advantages 311Content of the Take Care Scorecard 311Considerations for Health and Financial Literacy Scorecards 313Limitations 318Implications for Financial Literacy 318Summary 319Discussion Questions 320References 320About the Authors 324Acknowledgment 324Part Four Investor PsychologyChapter 18 Risk Perception and Risk Tolerance 327Victor Ricciardi and Douglas RiceIntroduction 327Risk Perception 328The Relationship between Risk Perception and Risk Tolerance 329An Overview of Risk Tolerance 329Measurement of Risk Tolerance 332The Role of Emotion in Risk Perception and Risk Tolerance 334Risk-Taking Behavior: The Influence of Market Moods, Business Cycles, and Economic Shocks 336Unresolved Issues in the Risk Domain 340Summary 341Discussion Questions 342References 342About the Authors 345Chapter 19 Emotions in the Financial Markets 347Richard FairchildIntroduction 347Behavioral Finance and Prospect Theory 348Emotions 350Emotions in the Financial Markets 351Emotional Finance and Unconscious Emotions 353Emotional Corporate Finance—A Formal Model 356Summary 360Discussion Questions 361References 361About the Author 364Chapter 20 Human Psychology and Market Seasonality 365Lisa A. KramerIntroduction 365Moods, Emotions, and Sentiment 366Weather, Mood, and Markets 366Daylight, Mood, and Markets 367Daylight Saving Time Changes, Mood, and Markets 373Elation, Deflation, and Markets 374Summary 376Discussion Questions 377References 377About the Authorr 380Chapter 21 Neurofinance 381Richard L. PetersonIntroduction 381Neuroscience Primer 382Research Methods 385The Neuroscience of Financial Decision-Making 387The Implications of Neurofinance Research for Practitioners 395Summary 397Discussion Questions 398References 398About the Author 401Chapter 22 Diversification and Asset Allocation Puzzles 403Dimitris GeorgarakosIntroduction 403Household Stock Market Participation 404Changes in Household Portfolios across Time 407Differences in Household Portfolios across Countries 408Portfolio Diversification 410Household Stock Trading Behavior 412Summary 415Discussion Questions 416References 416About the Author 420Chapter 23 Behavioral Portfolio Theory and Investment Management 421Erick W. Rengifo, Rossen Trendafilov, and Emanuela TrifanIntroduction 421Prospect Theory and Expected Utility Theory 421Safety-First Portfolio Theory 426SP/A Theory 427Behavioral Portfolio Theory 430Behavioral Asset Pricing Model 432The BAPM, CAPM, and Three-Factor Model 432Summary 435Discussion Questions 435References 435About the Authors 438Chapter 24 Post-Crisis Investor Behavior: Experience Matters 439Joseph V. RizziIntroduction 439Behavioral Finance Framework 440History Dependent Risk Tolerance: The Collective Memory Hypothesis 446Summary 452Discussion Questions 453References 453About the Author 455Part five Trading and Investing Psychology and StrategiesChapter 25 The Psychology of Trading and Investing 459Julia Pitters and Thomas OberlechnerIntroduction 459Personality Variables 461Affect and Cognition 463News, Rumors, and Market Mood 470Summary 471Discussion Questions 471References 472About the Authors 476Chapter 26 The Surprising Real World of Traders’ Psychology 477Denise K. Shull, Ken Celiano, and Andrew MenakerIntroduction 477What Science Reveals about How People Think 478I Need to Be a Hero Again 485The Heart of a Quant 487Summary 489Discussion Questions 490References 490About the Authors 493Chapter 27 Trading and Investment Strategies in Behavioral Finance 495John M. LongoIntroduction 495Distinction between Trading and Investment Strategies 496Active versus Passive Investment Strategies and Behavioral Finance 496Average Investors Suffer from Behavioral Biases 498Problems with Traditional Investment Strategies 499Short-Term Behaviorally Based Trading Strategies 503Long-Term Behaviorally Based Investment Strategies 508Current and Future Trends in Behavioral Finance Strategies 509Summary 510Discussion Questions 511References 511About the Author 512Part Six Special Investment TopicsChapter 28 Ethical and Socially Responsible Investing 515Julia M. PuaschunderIntroduction 515Socially Responsible Investment 515Historical Emergence 517International Differences 520Institutional Harmonization of FSR 523SRI in the Post 2008−2009 World Financial Crisis Era of Globalization 524Summary 525Discussion Questions 527References 527About the Author 532Chapter 29 Mutual Funds and Individual Investors: Advertising and Behavioral Issues 533John A. HaslemIntroduction 533Advertising and Performance 534Advertising, Expenses, and Flows 535Advertising, Emotions, and Choice 536Behavioral Persuasion In Advertising and Choice 539Education, Financial Knowledge, and Choice 540Emotions, Behavior, and Choice 542Emotions, Behavioral Finance, and Choice 543Financial Literacy and Active Management 544Price and Performance Sensitivity and Repricing 546Sentiment Contrarian Behavior and Actual Performance 548Summary 550Discussion Questions 552References 552About the Author 553Chapter 30 Real Estate Investment Decision-Making in Behavioral Finance 555Eli Beracha and Hilla SkibaIntroduction 555The Real Estate Market and the General Economy 556Real Estate Market and Financial Market 556Inefficiencies and the Real Estate Markets 557Observed Inefficiencies in Real Estate Markets 563Summary 569Discussion Questions 569References 570About the Authors 572Answers to the Discussion Questions 573Index 615