(continued from front flap) KOLB SERIES IN FINANCE Essential … · 2015. 9. 11. · FINANCE H.Kent Baker and John R. Nofsinger, Editors Investors, Corporations, and Markets KOLB

BEHAVIORALFINANCE

H.Kent Baker and John R. Nofsinger, Editors

Investors, Corporations,and Markets

KOLB SERIES IN FINANCEEssential Perspectives

Baker

Nofsin

ger

BEHAVIORAL FINANCEThe Robert W. Kolb Series in Finance is an unparalleled source of informa-tion dedicated to the most important issues in modern fi nance. Each book focuses on a specifi c topic in the fi eld of fi nance and contains contributed chapters from both respected academics and experienced fi nancial profes-sionals. As part of the Robert W. Kolb Series in Finance, Behavioral Finance aims to provide a comprehensive understanding of the key themes associated with this growing fi eld and how they can be applied to investments, corpora-tions, markets, regulations, and education.

Behavioral fi nance has the potential to explain not only how people make fi nancial decisions and how markets function, but also how to improve them. This book provides invaluable insights into behavioral fi nance, its psychological foundations, and its applications to fi nance.

Comprising contributed chapters by a distinguished group of academics and practitioners, Behavioral Finance provides a synthesis of the most essential elements of this discipline. It puts

behavioral fi nance in perspective by detailing the current state of research in this area and offers practical guidance on applying the information found here to real-world situations.

Behavioral fi nance has increasingly become part of mainstream fi nance. If you intend on gaining a better understanding of this discipline, look no further than this book.

KOLB SERIES IN FINANCEEssential Perspectives

( c o n t i n u e d f r o m f r o n t f l a p )

EAN: 9780470499115 ISBN 978-0-470-49911-5

( c o n t i n u e d o n b a c k f l a p )

$95.00 USA/$114.00 CAN

Behavioral fi nance has increasingly become

part of mainstream fi nance—helping to

provide explanations for our economic

decisions by combining behavioral and cognitive

psychological theory with conventional economics

and fi nance.

Filled with in-depth insights and practical advice,

this reliable resource—part of the Robert W. Kolb

Series in Finance—provides a comprehensive view

of behavioral fi nance by discussing the current

state of research in this area and detailing its poten-

tial impact on investors, corporations, and markets.

Comprising contributed chapters by distinguished

experts from some of the most infl uential fi rms

and universities in the world, Behavioral Finance

provides a synthesis of the essential elements of

this discipline including psychological concepts

and behavioral biases; the behavioral aspects of

asset pricing, asset allocation, and market prices;

investor behavior, corporate managerial behavior, and

social infl uences. Divided into six comprehensive

parts, it skillfully:

• Describes the fundamental heuristics, cognitive

errors, and psychological biases that affect

fi nancial decisions

• Discusses market ineffi ciency and behavioral-

based pricing models

• Explores corporate and executive behavioral fi nance

and examines the behavioral infl uences involving

their investment and fi nancing decisions

• Addresses how behavioral fi nance applies to

individual and institutional investors’ holdings

and their trading endeavors

• Shows how cultural factors and societal attitudes

affect markets

BE

HA

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INA

NC

E

Behavioral Finance contains the latest information

from some of the leading practitioners and academics

in this fi eld. Engaging and accessible, this book provides

a clear understanding of how people make fi nancial

decisions and their effects on today’s markets.

H. KENT BAKER, PHD, CFA, CMA, is

University Professor of Finance and Kogod

Research Professor at the Kogod School of

Business, American University. He has published

extensively in leading academic and professional

fi nance journals including the Journal of Finance,

Journal of Financial and Quantitative Analysis,

Financial Management, Financial Analysts Journal,

Journal of Portfolio Management, and Harvard

Business Review. Professor Baker is recognized as

one of the most prolifi c authors in fi nance during

the past fi fty years. He has consulting and training

experience with more than 100 organizations and

has been listed in fi fteen biographies.

JOHN R. NOFSINGER is an Associate Professor

of Finance and Nihoul Faculty Fellow at Washington

State University. He is one of the world’s leading

experts in behavioral fi nance and is a frequent

speaker on this topic at investment management

conferences, universities, and academic conferences.

Nofsinger has often been quoted or appeared in

the financial media, including the Wall Street

Journal, Financial Times, Fortune, BusinessWeek,

Bloomberg, and CNBC. He writes a blog called

“Mind on My Money” at psychologytoday.com.

Jacket Design: Leiva-Sposato

Jacket Illustration: © ImageClick, Inc. / Alamy

P1: OTA/XYZ P2: ABCfm JWBT306-Baker July 10, 2010 13:53 Printer Name: Hamilton


BEHAVIORALFINANCE


The Robert W. Kolb Series in Finance provides a comprehensive view of the fieldof finance in all of its variety and complexity. The series is projected to includeapproximately 65 volumes covering all major topics and specializations in finance,ranging from investments, to corporate finance, to financial institutions. Each vol-ume in the Kolb Series in Finance consists of new articles especially written for thevolume.

Each Kolb Series volume is edited by a specialist in a particular area of finance, whodevelops the volume outline and commissions articles by the world’s experts inthat particular field of finance. Each volume includes an editor’s introduction andapproximately thirty articles to fully describe the current state of financial researchand practice in a particular area of finance.

The essays in each volume are intended for practicing finance professionals, grad-uate students, and advanced undergraduate students. The goal of each volume isto encapsulate the current state of knowledge in a particular area of finance so thatthe reader can quickly achieve a mastery of that special area of finance.


BEHAVIORALFINANCE

Investors, Corporations,and Markets

Editors

H. Kent BakerJohn R. Nofsinger

The Robert W. Kolb Series in Finance

John Wiley & Sons, Inc.


Copyright c© 2010 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form or by any means, electronic, mechanical, photocopying,recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the1976 United States Copyright Act, without either the prior written permission of thePublisher, or authorization through payment of the appropriate per-copy fee to theCopyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923,(978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to thePublisher for permission should be addressed to the Permissions Department, JohnWiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011,fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have usedtheir best efforts in preparing this book, they make no representations or warranties withrespect to the accuracy or completeness of the contents of this book and specificallydisclaim any implied warranties of merchantability or fitness for a particular purpose. Nowarranty may be created or extended by sales representatives or written sales materials.The advice and strategies contained herein may not be suitable for your situation. Youshould consult with a professional where appropriate. Neither the publisher nor authorshall be liable for any loss of profit or any other commercial damages, including but notlimited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support,please contact our Customer Care Department within the United States at (800) 762-2974,outside the United States at (317) 572-3993 or fax (317) 572-4002.

Wiley also publishes its books in a variety of electronic formats. Some content thatappears in print may not be available in electronic books. For more information aboutWiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Behavioral finance : investors, corporations, and markets / H. Kent Baker andJohn R. Nofsinger, editors.

p. cm. – (The Robert W. Kolb series in finance)Includes index.ISBN 978-0-470-49911-5 (cloth); ISBN 978-0-470-76966-9 (ebk);ISBN 978-0-470-76967-6 (ebk); ISBN 978-0-470-76968-3 (ebk)1. Investments–Psychological aspects. 2. Investments–Decision making.

3. Finance–Psychological aspects. I. Baker, H. Kent (Harold Kent), 1944–II. Nofsinger, John R.

HG4515.15.B4384 2010336.201'9–dc22 2010010865

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

http://www.wiley.com/go/permissions

http://www.copyright.com

http://www.wiley.com


Contents

Acknowledgments ix

PART I Foundation and Key Concepts 1

1 Behavioral Finance: An Overview 3H. Kent Baker, John R. Nofsinger

2 Traditional versus Behavioral Finance 23Robert Bloomfield

3 Behavioral Finance: Application and Pedagogy inBusiness Education and Training 39Rassoul Yazdipour, James A. Howard

4 Heuristics or Rules of Thumb 57Hugh Schwartz

5 Neuroeconomics and Neurofinance 73Richard L. Peterson

6 Emotional Finance: The Role of the Unconscious inFinancial Decisions 95Richard J. Taffler, David A. Tuckett

7 Experimental Finance 113Robert Bloomfield, Alyssa Anderson

8 The Psychology of Risk 131Victor Ricciardi

9 Psychological Influences on Financial Regulationand Policy 151David Hirshleifer, Siew Hong Teoh

v


vi Contents

PART II Psychological Concepts and Behavioral Biases 169

10 Disposition Effect 171Markku Kaustia

11 Prospect Theory and Behavioral Finance 191Morris Altman

12 Cumulative Prospect Theory: Tests Using the StochasticDominance Approach 211Haim Levy

13 Overconfidence 241Markus Glaser, Martin Weber

14 The Representativeness Heuristic 259Richard J. Taffler

15 Familiarity Bias 277Hisham Foad

16 Limited Attention 295Sonya S. Lim, Siew Hong Teoh

17 Other Behavioral Biases 313Michael Dowling, Brian Lucey

PART III Behavioral Aspects of Asset Pricing 331

18 Market Inefficiency 333Raghavendra Rau

19 Belief- and Preference-Based Models 351Adam Szyszka

PART IV Behavioral Corporate Finance 373

20 Enterprise Decision Making as Explained inInterview-Based Studies 375Hugh Schwartz

21 Financing Decisions 393Jasmin Gider, Dirk Hackbarth


CONTENTS vii

22 Capital Budgeting and Other Investment Decisions 413Simon Gervais

23 Dividend Policy Decisions 435Itzhak Ben-David

24 Loyalty, Agency Conflicts, and Corporate Governance 453Randall Morck

25 Initial Public Offerings 475Francois Derrien

26 Mergers and Acquisitions 491Ming Dong

PART V Investor Behavior 511

27 Trust Behavior: The Essential Foundation ofFinancial Markets 513Lynn A. Stout

28 Individual Investor Trading 523Ning Zhu

29 Individual Investor Portfolios 539Valery Polkovnichenko

30 Cognitive Abilities and Financial Decisions 559George M. Korniotis, Alok Kumar

31 Pension Participant Behavior 577Julie Richardson Agnew

32 Institutional Investors 595Tarun Ramadorai

33 Derivative Markets 613Peter Locke

PART VI Social Influences 629

34 The Role of Culture in Finance 631Rohan Williamson


viii Contents

35 Social Interactions and Investing 647Mark S. Seasholes

36 Mood 671Tyler Shumway

PART VII Answers to Chapter Discussion Questions 681

Index 727


Acknowledgments

B ehavioral Finance: Investors, Corporations, and Markets represents the effortsof many people. At the core of the book is a distinguished group of aca-demics and practitioners who contributed their abundant talents to writing

and revising their respective chapters. Of course, the many scholars who havecontributed to the field of behavioral finance deserve mention and are referencedspecifically in each chapter. We are also grateful to those who reviewed the chap-ters and provided many helpful suggestions, especially Meghan Nesmith fromthe American University and Linda Baker. We appreciate the excellent work ofour publishing team at John Wiley & Sons, particularly Laura Walsh, JenniferMacDonald, and Melissa Lopez, as well as Bob Kolb for including this book inthe Robert W. Kolb Series in Finance. Special thanks go to Dean Richard Durandand Senior Associate Dean Kathy Getz from the Kogod School of Business Ad-ministration at the American University for providing support for this project.Finally, we are deeply indebted to our families, especially Linda Baker and AnnaNofsinger. These silent partners helped make this book possible as a result of theirencouragement, patience, and support.

ix


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PART I

Foundation and Key Concepts



CHAPTER 1

Behavioral Finance:An OverviewH. KENT BAKERUniversity Professor of Finance and Kogod Research Professor, American University

JOHN R. NOFSINGERAssociate Professor of Finance and Nihoul Finance Faculty Fellow,Washington State University

INTRODUCTIONBehavioral finance is a relatively new but quickly expanding field that seeks toprovide explanations for people’s economic decisions by combining behavioral andcognitive psychological theory with conventional economics and finance. Fuelingthe growth of behavioral finance research has been the inability of the traditionalexpected utility maximization of rational investors within the efficient marketsframework to explain many empirical patterns. Behavioral finance attempts toresolve these inconsistencies through explanations based on human behavior, bothindividually and in groups. For example, behavioral finance helps explain whyand how markets might be inefficient. After initial resistance from traditionalists,behavioral finance is increasingly becoming part of mainstream finance.

An underlying assumption of behavioral finance is that the information struc-ture and the characteristics of market participants systematically influence individ-uals’ investment decisions as well as market outcomes. The thinking process doesnot work like a computer. Instead, the human brain often processes informationusing shortcuts and emotional filters. These processes influence financial decisionmakers such that people often act in a seemingly irrational manner, routinely vi-olate traditional concepts of risk aversion, and make predictable errors in theirforecasts. These problems are pervasive in investor decisions, financial markets,and corporate managerial behavior. The impact of these suboptimal financial de-cisions has ramifications for the efficiency of capital markets, personal wealth, andthe performance of corporations.

The purpose of this book is to provide a comprehensive view of the psycho-logical foundations and their applications to finance as determined by the currentstate of behavioral financial research. The book is unique in that it surveys allfacets of the literature and thus offers unprecedented breadth and depth. The tar-geted audience includes academics, practitioners, regulators, students, and others

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(continued from front flap) KOLB SERIES IN FINANCE Essential … · 2015. 9. 11. · FINANCE H.Kent Baker and John R. Nofsinger, Editors Investors, Corporations, and Markets KOLB