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Behavioral Finance: Are the Disciples Profiting from the Doctrine?
Abstract
We analyze 16 mutual funds that are self-proclaimed or media-identified disciples of behavioral finance to determine whether: (a) they successfully attract investment dollars and (b) their strategies earn abnormal returns for their investors. We find these funds are successfully attracting investment dollars, outperform S&P 500 index funds, load especially heavily on the HML factor, but fail to earn risk-adjusted abnormal returns. Our results suggest behavioral mutual funds are tantamount to value investing and not much more.
... This paper is the first to examine how these behavioral funds performed during and after the recent financial crisis period, providing an ideal environment to test the conjecture that their strategies can exploit market inefficiencies and investors' behavioral biases. Secondly, a larger number of funds is employed relative to previous studies in the literature (see Wright, Banerjee and Boney, 2006, and Reinhart and Brennan, 2007), who reported inconclusive evidence due to the very small number of funds and short time period they examined. Thirdly, in contrast to the recent study of Santoni and Kelshiker (2010), who provide mainly descriptive statistics on funds' performance, we use a plethora of sophisticated performance evaluation measures that can formally test the existence of superior managerial performance adjusting for common risk factors and using different benchmark indices as well as for their market timing ability. ...
... Reinhart and Brennan (2007) examined the performance of 9 behavioral mutual funds during the period 1997–2003; they also compared behavioral funds' performance with traditional mutual funds (in terms of premia, alphas, Sharpe ratios, Treynor ratios and information ratios) and showed that inefficiencies can actually improve portfolios' performance, mainly when examining large-cap behavioral funds. In the same spirit, Wright et al. (2006) examined the performance of 16 behavioral funds since their inception date, identifying their ability to attract investment flows. They found that even though behavioral funds as a group outperform S&P 500 index funds, they did not deliver abnormal returns once they account for size, value and 1. Identifying the appropriate benchmark index is of particular importance in order to measure the performance of the fund managers (Tabner, 2009). ...
... This is because they examine a relatively small number of funds, using different and rather short sample periods. Moreover, with the exception of Wright et al. (2006), this mixed evidence can be attributed to the use of rather simple performance measures that fail to properly account for market risk as well as other common factors, such as size, value and momentum. ...
... Reinhart and Brennan (2007) examined the performance of 9 behavioral mutual funds during the period 1997–2003; they also compared behavioral funds' performance with traditional mutual funds (in terms of premia, alphas, Sharpe ratios, Treynor ratios and information ratios) and showed that inefficiencies can actually improve portfolios' performance, mainly when examining large-cap behavioral funds. In the same spirit, Wright et al. (2006) examined the performance of 16 behavioral funds since their inception date, identifying their ability to attract investment flows. They found that even though behavioral funds as a group outperform S&P 500 index funds, they did not deliver abnormal returns once they account for size, value and 1. Identifying the appropriate benchmark index is of particular importance in order to measure the performance of the fund managers (Tabner, 2009). ...
... This is because they examine a relatively small number of funds, using different and rather short sample periods. Moreover, with the exception of Wright et al. (2006), this mixed evidence can be attributed to the use of rather simple performance measures that fail to properly account for market risk as well as other common factors, such as size, value and momentum. ...
... The study covers the recent global financial crisis period and its aftermath, i.e. the period from January 2007 to March 2013, and examines the performance of 22 US behavioral mutual funds using monthly returns. 2 Table 1provides the details of the funds used. To build our dataset, we firstly include the same funds that prior studies have used (see Reinhart and Brennan, 2007, Wright et al., 2006, 2008, and Santoni and Kelshiker, 2010). In addition to these funds, an extensive search on Bloomberg fund database was conducted in order to identify other funds that explicitly state in their prospectuses that they follow behavioral strategies. ...
... The respective regional MSCI market index is used as a proxy for the market. When comparing the performance of behavioural finance funds with the market, we follow Wright et al (2008) in using raw returns as well as riskadjusted returns. All analyses are conducted for bull and bear market periods separately. ...
... , and we add behavioural finance funds that have been created since these four studies were published. A mutual fund qualifies as a behavioural finance fund if there is publicly available written confirmation that behavioural finance insights are used to make investment decisions (Wright et al, 2008Elton et al, 1996). When adding new funds, we exclude those that engage in pure momentum or contrarian trading strategies but include all those based on behavioural finance in general. ...
... Once adjusted for risk, US, global and European behavioural finance funds neither outperform nor underperform the market significantly. This finding is consistent with Wright et al (2008). The size factor from the Fama–French 3-factor model appears to be the driving force of fund returns. ...
This article compares the performance of behavioural finance funds with the performance of the market and that of matched mutual funds across the major regions of the world from 1990 to 2010. Performance is measured raw and risk-adjusted. The empirical evidence suggests that behavioural finance funds neither outperform nor underperform the market or matched actively managed mutual funds. Overall, the empirical findings vary strongly with the set-up of the investigation. We conclude that either stock markets are more efficient, or fund management is worse, than behavioural finance funds advertise. This is consistent with other studies’ results.
... La Prospect Theory, desarrollada por Kahneman y Tversky (1979) La literatura aporta un nuevo matiz a esta idea ya que aquellos trabajos (Reinhart y Brennan, 2007 y Wright et al., 2008) que son anteriores a la actual crisis financiera consideran que los BF mejoran el rendimiento del mercado. Sin embargo, Santoni y Kelshiker (2010), distinguen entre periodos alcistas y bajistas y obtienen que los BF sólo baten al mercado en los periodos alcistas. ...
... Para su elección, se ha tenido en cuenta el único fondo del vicio que existe, el VICEX. Por lo que respecta al grupo de BF, se han utilizado 5 de los 16 reflejados en el análisis de Wright et al. (2008), y se han añadido uno más de JP Morgan 4 . Por último, se emparejan los BF con seis FISR a partir de la base de datos de fondos del Social Investment Forum 5 , de acuerdo con la metodología matched pair analysis (Mallin, 1995). ...
... La muestra final está constituida por seis BF, seis FISR y el VF. Además, se considera como benchmark del mercado el S&P500 porque suele ser utilizado con frecuencia en la literatura (Sauer, 1997; Wright et al., 2008 y Statman, 2000). ...
The aim of this paper is to analyze the return and risk of different categories of funds managed using non-conventional management criteria, in order to test which achieve a better performance. Three periods, two bullish phases and one bearish phase, were analyzed. Three categories of non-conventional investment funds were examined: socially responsible investment funds, funds based on the principles of Behavioral Finance, and finally the Vice Fund, applying a medium-difference analysis and a multivariate analysis along with the Sharpe ratio and information ratio. No significant differences were found between the returns of the three categories, except as regards their volatility. Using the estimated multivariate model it was not possible to get significant differences between the three categories of funds or the market index in most cases. Ratio analysis enabled us to establish a fund ranking, but was unable to show which management was the most appropriate throughout the different periods.
Orientation: Behavioural finance research suggests that human biases can cause irrationalities which have a significant impact on decision making. Discovery Bank is an organisation that attempts to apply behavioural finance to improve the financial health of its clients.
Research purpose: This study attempts to determine the extent to which the Discovery Bank business model is grounded in behavioural finance theory.
Motivation for the study: Discovery Bank is the first bank to leverage behavioural insights to improve personal financial decisions.
Research approach/design and method: This study followed an explanatory case study methodology with primary data sources being interviews with key employees, academic research and electronic artefacts. The Discovery Bank business model was evaluated against the behavioural finance theoretical framework to establish the extent to which it conforms to behavioural finance theories.
Main findings: The Discovery Bank business model is grounded in behavioural finance theory to a significant extent, with emphasis on modifying the behaviours that inhibit financial well-being. The bank generally uses incentives rather than nudges as behaviour modification tools.
Practical/managerial implications: Whilst behavioural finance continues to attract substantial attention in finance research, its practical implications for the banking industry and personal finance are largely unexplored. Furthermore, the study contributes to the literature by examining the behavioural finance theoretical framework in the context of the banking and the broader financial services industry.
Contribution/value-add: This research may be of value to practitioners in the financial industry as it explores a unique business model. Researchers on behavioural finance may find value in the practical application of the theoretical framework.
This study examined the effect of decision making and execution on the operational activities of Pension Fund Administrators in Nigeria. The study employed a survey research design with a population of 10 Pension Fund Administrators in Nigeria. Primary data employed for the study were analysed using the Chi-square analytical technique. The s Research results show that managers take account of organization’s strategic objectives which translate to good performance when making a decision. The study therefore recommends that strategic decisions should be well taken by managers to be able to deliver on the strategic objectives of the organizations they represent. Keywords: Decision-Making, Organizations, Performance, Strategic-Objective, PFAs
This study investigated the impact of Code of Corporate governance on the auditor’s expectation gap, following the implementation of the Nigerian corporate governance code. The study outcomes were based on the literature review, the analysis of the qualitative data and discussions of generated themes. The results revealed that adopting effective corporate governance (accountability) system positively contributes in narrowing the audit expectation gap due to the increasing interest in the role of accountability in fighting corruption in Nigeria. The Study recommends; the need for continued sensitization of the public, by both the auditing profession and other stake holders on the role and duties of the auditor, management and the board to avoid expectation gap from the public. The CBN, NAICOM, PENCOM and NCC should implement and enforce the approved Code of Governance. Keywords: Audit Expectation Gap, Corporate Accountability, Audit committees, Code of Corporate Governance, Regulatory agencies.
The field of behavioral finance has attempted to explain the role of biases, heuristics, and inefficiencies present in financial markets. This paper contains a comprehensive literature review of behavioral finance, as well as inputs from more recent papers of the subject. The various subtopics of behavioral finance will also be analyzed, which include loss aversion, corporate finance, and momentum/contrarian investing. Finally, this paper will draw unique conclusions across behavioral finance and hypothesize about what topics within behavioral finance are likely to show most interesting impacts on behavior of financial markets, hence are area of research in the near future.
In diesem Abschnitt werden ausgewählte Anwendungen der Ideen der Behavioral Economics vorgestellt. Behavioral Finance, Sozialpolitik und die Idee des liberalen Paternalismus, der versucht, mit den Ideen der Behavioral Economics das Verhalten der Menschen zu beeinflussen.
Directora: Mª del Carmen González Velasco RESUMEN Este artículo analiza la relación existente entre el rendimiento de fondos de inversión gestionados bajo criterios alejados de los convencionales para corroborar qué tipo de gerencia obtiene mejor rendimiento diferenciando dos períodos de análisis, uno expansivo y otro de crisis. Para ello seleccionamos un fondo ISR (DSEFX), un fondo guiado por los principios del Behavioral Finance (UBVAX) y por último el Vice Fund (VICEX) y aplicamos un análisis de diferencia de medias así como un estudio de los ratios de Jensen y Sharpe. Los resultados muestran que no se pueden establecer diferencias estadísticamente significativas entre las rentabilidades de los fondos, pero sí con respecto a sus volatilidades. Los ratios de Jensen y Sharpe nos permiten concluir que el UBVAX es el fondo que logra un mejor rendimiento aunque los datos no son siempre estadísticamente significativos. ABSTRACT The aim of this paper is to analyze the relationship between the performance of funds managed under the criteria away from conventional management to corroborate what gets better performance distinguishing between two periods of analysis, one expansive and another one crisis. We select a SRI fund (DSEFX), a fund based on the principles of Behavioral Finance (UBVAX) and finally the Vice Fund (VICEX) to apply a mean difference analysis and a study of Jensen and Sharpe ratios. The results show that differences were not statistically significant between the returns of the funds, but with respect to their volatility. The Jensen and Sharpe ratios allow us to conclude that is the background UBVAX achieves better performance although the data are not always statistically significant.
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis (EMH)—the idea that competitive financial markets exploit all available information when setting security prices—has been singled out for particular attention. Like all successful theories, the EMH has major limitations, even as it continues to provide the foundation for not only past accomplishment, but future advances in the field of finance.
Despite the theory's undoubted limitations, the claim that it is responsible for the current worldwide crisis seems wildly exaggerated. This essay shows the misreading of the theory and logical inconsistencies involved in popular arguments that EMH played a significant role in (1) the formation of the real estate and stock market bubbles, (2) investment practitioners' miscalculation of risks, and (3) the failure of regulators to recognize the bubbles and avert the crisis. At the same time, the author argues that the collapse of Lehman Brothers and other large financial institutions, far from resulting from excessive faith in efficient markets, reflects a failure to heed the lessons of efficient markets. In the author's words, “To me, Lehman's demise conclusively demonstrates that, in a competitive capital market, if you take massive risky positions financed with extraordinary leverage, you are bound to lose big one day—no matter how large and venerable you are.”
Finally, behavioral finance, widely considered as challenging and even supplanting efficient markets theory, is viewed in this article as complementing if not reinforcing efficient markets theory. As the author says, “it takes a theory to beat a theory.” Behavioralism, for all its important contributions to finance literature, is described as not a theory but rather “a collection of ideas and results”— one that depends for its existence on the theory of efficient markets.
A rapidly growing literature claims to reject the efficient market hypothesis by producing large estimates of long-term abnormal returns following major corporate events. The preferred methodology in this literature is to calculate average multiyear buy-and-hold abnormal returns and conduct inferences via a bootstrapping procedure. We show that this methodology is severely flawed because it assumes independence of multiyear abnormal returns for event firms, producing test statistics that are up to four times too large. After accounting for the positive crosscorrelations of event-firm abnormal returns, we find virtually no evidence of reliable abnormal performance for our samples.
This paper identifies five common risk factors in the returns on stocks and bonds. There are three stock-market factors: an overall market factor and factors related to firm size and book-to-market equity. There are two bond-market factors, related to maturity and default risks. Stock returns have shared variation due to the stock-market factors, and they are linked to bond returns through shared variation in the bond-market factors. Except for low-grade corporates, the bond-market factors capture the common variation in bond returns. Most important, the five factors seem to explain average returns on stocks and bonds.
We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management. Copyright The American Finance Association 2000.
A great amount of effort is spent in forecasting the outcome of sporting events, but few papers have focused exclusively on the characteristics of sports forecasts. Rather, many papers have been written about the efficiency of sports betting markets. As it turns out, it is possible to derive considerable information about the forecasts and the forecasting process from the studies that tested the markets for economic efficiency. Moreover, the huge number of observations provided by betting markets makes it possible to obtain robust tests of various forecasting hypotheses. This paper is concerned with a number of forecasting topics in horse racing and several team sports. The first topic involves the type of forecast that is made: picking a winner or predicting whether a particular team beats the point spread. Different evaluation procedures will be examined and alternative forecasting methods (models, experts, and the market) will be compared. The paper also examines the evidence about the existence of biases in the forecasts and concludes with the applicability of these results to forecasting in general.