Meir Statman

Santa Clara University | SCU · Department of Finance

Purpose The purpose of this paper is to depict how the author's way from standard finance to the first and second generations of behavioral finance illustrates the ongoing general transition. Design/methodology/approach The first generation, starting in the early 1980s, largely accepted standard finance's notion of people's wants as “rational” wan...

Some people with high financial well‐being are wealthy, but many more are middle class people who earn adequate incomes throughout their working years, save enough, and spend their savings judicially in retirement. Many bear the difficult task of saving enough during their working years and the equally difficult task of spending the right amount in...

Financial economists writing about financial advertising often describe them as fluff at best and misleading or fraudulent at worst. This description typifies the first generation of behavioral finance that described people as irrational, misled by ads into cognitive and emotional errors. The second generation of behavioral finance describes people...

Economic and social policies vary across countries, reflecting their cultures and shaping them. People in some countries are more loss averse than in others. People in some countries express stronger preferences for income equality than do people in others, and some countries offer stronger safety nets than others do. The cultural dimension of unce...

Why do levels of corporate social performance (CSP) differ so much across countries? We answer this question in an examination of CSP ratings of more than 2600 companies from 36 countries. We find that firm characteristics explain very little of the variations in CSP ratings. In contrast, variations in country factors such as stages of economic dev...

This article offers a factor model for classifying socially responsible mutual funds and measuring their performance. The authors provide a factor model that consists of six factors: the four widely used factors of market, smalllarge (SMB), valuegrowth (HML), and momentum, and two social responsibility factors, reflecting the criteria most widely u...

Advertising for investment products has changed over the past 50 years. Ads initially targeted investors as defined in standard finance: that is, as fact-seeking utility maximizers. Ad portrayals gradually changed to target consumers, defined as people pursuing diverse life projects. Verbal and factual appeals were supplanted by rhetorical, figurat...

We employ a liability directed investment (LDI) rebalancing framework based on expected shortfall (ES), which we refer to as LDI-ES, to prescribe remedies for an underfunded portfolio. Investors in the LDI-ES framework face a risky asset, such as a stock index, and a risk-free bond. They begin with some level of current wealth and set their target...

Behavioral finance is under construction as a solid structure of finance. It substitutes normal people for rational people in standard finance, behavioral portfolio theory for mean-variance portfolio theory, and behavioral asset pricing models for the CAPM and other models where expected returns are determined only by risk. Behavioral finance also...

Behavioral finance is under construction as a solid structure of finance. It incorporates parts of standard finance, replaces others, and includes bridges between theory, evidence, and practice. Behavioral finance substitutes normal people for the rational people in standard finance. It substitutes behavioral portfolio theory for mean-variance port...

The authors present a liability-directed investment (LDI) rebalancing framework that is based on expected shortfall (ES), denoted as LDI?ES, to prescribe remedies for an underfunded portfolio. Investors endowed with some current wealth optimize their target wealth at the end of N periods, subject to their tolerance for shortfalls from that target w...

Nudges toward voluntary defined-contribution retirement savings have moved many non-savers into savings but have left many behind. I argue that it is time to switch from libertarian-paternalistic nudges to fully paternalistic shoves. I draw on evidence from the United States and other countries to advocate a retirement savings solution centered on...

Gaps between optimized portfolios produced by mean-variance optimizers and portfolios that investors prefer come from two sources. One is imprecise estimates of mean-variance parameters. The other is investor preferences beyond high expected returns and low risk. We offer the mean-variance ‘efficient range’ as the location of all mean-variance effi...

Options and structured products have no roles in mean–variance portfolios, but they have roles in behavioral portfolios. Behavioral portfolios are composed of mental account sub-portfolios, each associated with a goal, such as retirement income or bequest. Investors optimize each mental account by finding the assets and asset allocation that maximi...

Proponents of corporate environmental responsibility argue that corporations shortchange shareholders by investing too little in environmental responsibility. They claim that corporations can improve their financial performance by increasing their investment in environmental responsibility. Opponents of corporate social responsibility argue that co...

Typical risk questionnaires aimed at helping advisors guide investors are deficient in five ways. First, each investor has a multitude of risk tolerances, one for each goal and its mental account. Probes for one global risk tolerance miss that multitude. Second, the links between answers to questions in risk questionnaires and recommended portfolio...

We explore, through a survey of more than 2,500 people, the links between personality and risk tolerance, overconfidence, maximization, regret, trust, attributing success to luck or skill, and life-satisfaction. Risk tolerance is high among those with high levels of Extraversion and Openness but relatively low among those with high levels of Consci...

Financial well-being is distinct from income. Some people with high incomes suffer low financial well-being, as their incomes fall short of their aspirations. Such people feel propelled to reach their aspirations by taking risk and willing to bear losses. Conversely, some people with low incomes enjoy high financial well-being, as their incomes exc...

Fairness matters to financial advisors, whether fairness in financial markets or fairness in their relations with clients. Yet perceptions of fairness vary greatly and they are hotly debated everywhere, including politics, education, medicine, law, and finance. I explore fairness in finance in the context of insider trading. Do perceptions of the f...

A belief that markets are efficient is blamed for instigating the crisis we are in and lulling us into complacency as the crisis was approaching. But the debate about the role of such belief in the crisis is unfocused for two reasons. First, a lack of a common definition of market efficiency precludes a common language. Second, efficient markets ar...

Why were the returns of stocks with low book-to-market ratios and high market capitalizations lower, on average, than the returns of stocks with high book-to-market ratios and low market capitalizations? In this paper we pit the characteristics hypothesis against the affect hypothesis. The characteristics hypothesis says that some characteristics,...

This is the introduction to the book, “What Investors Really Want.” The book centers on behavioral finance, drawing from research in finance, psychology and marketing, and combining systematic studies with anecdotes and recent events. The book presents the cognitive errors that bedevil investors, such as framing and hindsight errors, and the emotio...

We show empirically that firms behave remarkably similarly to how their CEOs behave personally in the context of leverage choices. Using a database of CEOs' leverage in their most recent home purchases, we find a positive, economically significant, robust relation between personal home leverage and corporate leverage in the cross-section and when w...

While correlation is the common measure of the benefits of diversification, it is not a good measure. This is for two reasons. First, the benefits of diversification depend not only on the correlations between stock returns but also on the standard deviations of stock returns. Second, correlation does not provide an intuitive measure of the benefit...

Cultural background affects the attitudes of immigrants long after they have settled in their new countries, and it affects the attitudes of their descendents as well. For example, levels of trust persist among immigrants to the United States, and relatively high levels of trust among immigrants are associated with relatively high levels of trust i...

This study explores the links between culture and risk tolerance, based on surveys conducted in 23 countries. Altogether, more than 4,000 individuals participated in the surveys.Risk tolerance is associated with culture. Risk tolerance is relatively low in countries where uncertainty avoidance is relatively high and in countries which are relativel...

The use of past peak prices as reference points or judgmental anchors in valuing targets affects several aspects of merger and acquisition activity including offer prices, deal success, market reaction, and merger waves. Offer prices cluster at the target's recent peak prices, as well as 25% and 50% above recent peaks, even though these specific pr...

Typical risk questionnaires aimed at helping advisors guide investors are deficient in five ways. First, each investor has a multitude of risk tolerances, one for each mental account. Probes for a global risk tolerance miss that multitude. Second, the links between answers to questions in risk questionnaires and recommended portfolio allocations ar...

We integrate appealing features of Markowitz s behavioral portfolio theory (BPT) into a new mental accounting (MA) framework. Features of the MA framework include an MA structure of portfolios, a definition of risk as the probability of failing to reach the threshold level in each mental account, and attitudes toward risk that vary by account. We d...

Why were the returns of stocks with low book-to-market ratios and high market capitalization's lower, on average, than the returns of stocks with high book-to-market ratios and low market capitalization's? In this paper we pit the characteristics hypothesis against the affect hypothesis. The characteristics hypothesis says that some characteristics...

Do stocks of admired companies yield admirable returns? Are increases in admiration followed by high stock returns? And how reliable is the relation between admiration and returns? These are the questions we answer in this paper. We study Fortune magazine’s annual list of “America’s Most Admired Companies” and find that stocks of admired companies...

Why were the returns of stocks with low book-to-market ratios and high market capitalizations lower, on average, than the returns of stocks with high book-to-market ratios and low market capitalizations? In this paper we pit the characteristics hypothesis against the affect hypothesis. The characteristics hypothesis says that some characteristics,...

We are in the midst of what might end up as the most significant change to financial regulations since the Great Depression. This is because the financial and economic crisis that continues to engulf us is the most severe crisis since the Great Depression. The markets for houses, mortgages, and derivatives linked to them have played critical roles...

Today's portfolios are often composed of mental accounts, one for each of an investor's goals. They often also contain derivative securities. We develop a methodology for optimizing mental accounting portfolios that contain derivatives and other securities with non-normal distributions of returns, including distributions with very fat tails. This m...

Typical socially responsible investors tilt their portfolios toward stocks of companies with high scores on social responsibility characteristics and shun stocks of companies associated with tobacco, alcohol, gambling, firearms, and military or nuclear operations. Analyzing 1992-2007 returns of stocks rated on social responsibility, this study foun...

The global crisis that unfolded in 2008, and is still front and center today, reminds us that the hidden hand of self inter-est does not assure economic welfare. Social capital in the form of fairness, trust, and cooperation must supplement self interest, and the government must supplement both self interest and social capital with laws and regulat...

The global financial and economic crisis of the late 2000s highlights the ongoing tug-of-war between those who pull toward free markets and those who pull toward strict regulation of markets. It also highlights the sometimes parallel and sometimes perpendicular tug-of-war between those who pull toward libertarianism and those who pull toward patern...

Clients want more than advisors who allocate assets in their portfolios. They want advisors who empathize with their goals, whether a secure retirement, a vacation home, or social responsibility. Socially responsible investors want to integrate their personal values into their investment decisions and they look for advisors who do not lecture them...

Typical socially responsible investors tilt their portfolios toward stocks of companies with high scores on social responsibility characteristics such as community, employee relations and the environment. We analyze returns during 1992-2007 of stocks rated on social responsibility by KLD and find that this tilt gave socially responsible investors a...

Behavioral finance is a framework that augments some parts of standard finance and replaces other parts. It describes the behavior of investors and managers; it describes the outcomes of interactions between investors and managers in financial and capital markets; and it prescribes more effective behavior for investors and managers.

Behavioral finance has made important contributions to the field of investing by focusing on the cognitive and emotional aspects of the investment decision-making process. Although it is tempting to say that people are the same everywhere, the collective set of common experiences that people of the same culture share will influence their cognitive...

Stocks, like houses, cars, watches, and other products, exude affect - that is, they are considered good or bad, beautiful or ugly; they are admired or disliked. Affect plays an overt role in the pricing of houses, cars, and watches, but according to standard financial theory, it plays no role in the pricing of financial assets. This article outlin...

Paul Bond is a lawyer who overheard two other lawyers at his office discussing the proposed purchase of a company by one of their clients. He proceeds to buy shares of this company. Would you rate Bond’s behavior completely fair, acceptable, unfair, or very unfair? I posed this vignette to samples of university students in China, Taiwan, and the U....

Socially responsible investors attempt to integrate their ethical, societal and religious values with their investments. They find it impossible to separate the utilitarian characteristics of an investment, namely its risk and expected returns, from its expressive characteristic of social responsibility. Not all values are shared by all investors a...

What do we know about SRI? What distinguishes socially responsible companies from conventional companies? Should investors expect socially responsible investments to yield higher or lower returns than conventional investments? What has been the performance of socially responsible portfolios relative to conventional portfolios? What are the tracking...

Socially responsible investors are similar to conventional investors in some ways but different in others. Like conventional investors, socially responsible investors want high returns and low risk, but socially responsible investors also want their portfolios to conform to their values, whether promotion of worker rights, opposition to war, or pro...

Correlation is the common indicator for the benefits of diversification, but it is not a good indicator. This is for two reasons. First, the benefits of diversification depend not only on the correlations between returns but also on the standard deviations of returns. Second, correlation does not provide an intuitive measure of the benefits of dive...

Ethics, fairness, trust, and freedom from corruption are parts of social capital, and social capital matters in financial markets. Investors consider not only the information they receive but also their trust in the accuracy of the information and the fairness of the markets in which to trade. Deficiencies in ethics and fairness mark all countries....

Do stocks of admired companies yield admirable returns? We study Fortune magazine's annual list of "America's Most Admired Companies" and find that stocks of admired companies had lower returns, on average, than stocks of despised companies during the 23 years from April 1983 through March 2006. We link differences between the returns of stocks of...

We compare price-to-earnings ratios and dividend yields, which are indirect measures of sentiment, with the bullish sentiment index, which is a direct measure. We find that the sentiment index does better as a market-timing tool than do P/E ratios and dividend yields, but none is very reliable. We do not argue that market timing is impossible. Rath...

Ethics, fairness, trust and freedom from corruption are all parts of social capital and social capital matters in financial markets because investors consider not only their tradeoff between risk and return based on available information but also their trust in the accuracy of information and the fairness of markets. Deficiencies in ethics and fair...

Assets are economically liquid when they can be sold quickly with no loss relative to their fair market value. Assets are "mentally liquid" when they offer investors options to obscure losses relative to reference prices and options to avoid their realization. Purchase prices are common references prices but other prices, such as the maximum price...

The proposition that investors are overconfident about their valuation and trading skills can explain high observed trading volume. With biased self-attribution, the level of investor overconfidence and thus trading volume varies with past returns. We test the trading volume predictions of formal overconfidence models and find that share turnover i...

Socially responsible investment (SRI) indexes vary in composition and social responsibility scores, but have higher mean social scores than the S&P 500 index. Socially responsible indexes differ in the emphasis they place on social characteristics. The DS 400 index is the strongest among all indexes on the environment, for example, while the Calver...

The purpose of this paper is to explore differences among countries in perceptions of the fairness of trading in financial markets and offer these perceptions as measures of social capital in financial markets. What are the differences in the perceptions of insider trading among different countries? Are the judgments of students similar to those of...

Een ideale aandelenmarkt wordt vaak be schreven als een level playing field, waar de handel op een eerlijke wijze tot stand komt. Wat zijn de regels omtrent eerlijk handelen? Sociaal-maatschappelijke normen en waarden, inclusief die met betrekking tot eerlijk handelen, vinden in de regel hun neerslag in de vorm van wetten. Maar dat betekent niet da...

Social norms, including rules of fairness, are rules of behavior enforced by the community that often make their way into law. Community rules of fairness in financial trading are important to everyone, but they are especially important to investors, to executives, to investment professionals, to students who plan to become executives or investment...

Investors who follow different tenets of social responsibility and choose different socially responsible mutual funds can be described as members of different religions. Some social responsibility religions have a single tenet, such as protection of the environment, while other social responsibility religions combine several tenets, such as avoidan...

While correlation is the common indicator of the benefits of diversification, it is not a good indicator. This is for three reasons. First, diversifiable risk depends not only on the correlations between stock returns but also on the standard deviations of stock returns. Second, correlation does not provide an intuitive indicator of the benefits of...

When we talk about ethics we often talk about fairness. What are the rules of fairness that govern financial trading? Social norms, including rules of fairness, are rules of behavior that are enforced by the community and often make their way into law. Community rules of fairness in financial trading are important to all people since financial mark...

acknowledge support from The Dean Witter Foundation. Socially responsible indexes: Composition, performance and tracking errors Abstract One purpose of this study is to explore the characteristics that define socially responsible companies by comparing the content of the S&P 500 Index of conventional companies to the contents of four indexes of soc...

One purpose of this study is to explore the characteristics that define socially responsible companies by comparing the content of the S&P 500 Index of conventional companies to the contents of four indexes of socially responsible companies, the Domini 400 Social Index (DS 400 Index), the Calvert Social Index, the Citizens Index, and the U.S. porti...

Martha Stewart taught us how to set a dinner table, decorate a cake, and make a Christmas wreath. She never meant to teach us about investments, but she did. The portfolio that Martha Stewart revealed to prosecutors and the jury at her trial is a portfolio of a normal investor, containing both winners and losers, and the investment behavior she rev...

Investment bankers, security analysts, traders, and other finance professionals often behave as if they lived in a cocoon. They need to recognize that they live under the community's rules of fairness as well as the market's rules. Through anecdotes, quotations, and survey reports, this article discusses how internal and external obstacles keep fin...

Correlations between the returns of U.S. stocks and international stocks were higher recently than in the past, reaching 0.86 during the 60 months ending in December 2003. Today's investors note the high correlations between U.S. and international stocks and doubt the benefits of global diversification. We argue that the benefits of global diversif...

We listen to investors brag about their winning stocks and want to ask "May I have a list of all the stocks in your portfolio?" Polite people resist the urge but prosecutors need not be polite. The portfolio that Martha Stewart revealed to prosecutors and the jury at her trial is a portfolio of normal investors, containing both winners and losers,...

Correlation is the common measure of the benefits of diversification, but dispersion, measured as the standard deviation of the returns of stocks around the mean of all stocks, is better. This is for two reasons. First, the benefits of diversification depend not only on the correlations between stock returns but also on the standard deviations of s...

The 1960 issue of the Financial Analysts Journal contains a pair of remarkable articles. In the first, Edward F. Renshaw and Paul J. Feldstein proposed the creation of what we know today as index funds. In the second, John B. Armstrong argued against index funds. John B. Armstrong is a pen-name of John C. Bogle, the founder of Vanguard who introduc...

What do investors want? Abstract Diners want more than the utilitarian benefits of low cost and high nutrition when they choose restaurants, they want the utilitarian benefits of palatability, ambiance and conformity to culture. And they also want the expressive benefits of status, patriotism and social responsibility. Similarly, investors want mor...

It is easy, in hindsight, to conclude that all but a handful of investors were exuberantly bullish at the top of the market in 1999 and that all bullishness disappeared by 2002. But foresight is not hindsight, and today's promises of sure market timing are as misleading as yesterday's. Expectations of investors during the time of the bubble and its...