Psychology of Investing / Edition 4

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Overview

See the decision-making process behind investments.

The Psychology of Investing is the first text of its kind to delve into the fascinating subject of how psychology affects investing. Its unique coverage describes how investors actually behave, the reasons and causes of that behavior, why the behavior hurts their wealth, and what they can do about it.

The fourth edition addresses the current financial crisis, has a new chapter on framing effects, and contains new evidence and ideas in every chapter.

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Product Details

  • ISBN-13: 9780136117032
  • Publisher: Prentice Hall
  • Publication date: 3/2/2010
  • Series: Pearson Custom Business Resources Series
  • Edition description: Older Edition
  • Edition number: 4
  • Pages: 144
  • Product dimensions: 7.20 (w) x 9.00 (h) x 0.40 (d)

Table of Contents

Preface ix

Chapter 1 Psychology and Finance 1

Traditional versus Behavioral Finance 2

Prediction 3

Behavioral Finance 5

Sources of Cognitive Errors 6

Bias and Wealth Impact 8

What to Expect 9

Questions 10

Endnotes 10

Chapter 2 Overconfidence 11

Overconfidence Affects Investor Decisions 12

Overconfident Trading 13

Overconfidence and the Market 16

Overconfidence and Risk 16

Illusion of Knowledge 17

Illusion of Control 19

Choice 19

Outcome Sequence 19

Task Familiarity 19

Information 19

Active Involvement 19

Past Successes 20

Online Trading 20

Online Trading and Performance 21

Questions 22

Endnotes 22

Chapter 3 Pride and Regret 24

Disposition Effect 24

Disposition Effect and Wealth 25

Tests of Avoiding Regret and Seeking Pride 26

International Tests of the Disposition Effect 28

Disposition Outside the Stock Market 28

Selling Winners Too Soon and Holding Losers Too Long 29

Disposition Effect and News 29

Reference Points 30

Can the Disposition Effect Impact the Market? 31

Disposition and Investor Sophistication 32

Summary 32

Questions 33

Endnotes 33

Chapter 4 Risk Perceptions 35

House-Money Effect 36

Snakebite (or Risk Aversion) 36

Trying to Break Even 36

Effect on Investors 37

Endowment (or Status Quo Bias) Effects 38

Endowment and Investors 39

Perception of Investment Risk 39

Memory and Decision Making 40

Memory and Investment Decisions 40

Cognitive Dissonance 41

Cognitive Dissonance and Investing 41

Summary 44

Questions 44

Endnotes 44

Chapter 5 Decision Frames 46

Framing and Choice 46

Framing and Investing 48

Framing and the Risk-Return Relationship 48

Framing and Prediction 50

Thinking Mode and Decision Processes 50

Measuring Thinking Mode 51

Risk Framing and Thinking Style 52

Framing Pension Decisions 53

Summary 53

Questions 54

Endnotes 54

Chapter 6 Mental Accounting 55

Mental Budgeting 56

Matching Costs to Benefits 56

Matching Debt 57

Sunk-Cost Effect 58

Economic Impact 59

Mental Accounting and Investing 60

Investor Trading 60

Asset Allocation 61

Market Impact 64

Questions 64

Endnotes 65

Chapter 7 Forming Portfolios 66

Modern Portfolio Theory 66

Mental Accounting and Portfolios 66

Perceptions on Risk 68

Risk Perception in the Real World 70

Building Behavioral Portfolios 70

Household Portfolios 72

Na?ve Diversification 73

Retirement Plans 74

Questions 75

Endnotes 75

Chapter 8 Representativeness and Familiarity 76

Representativeness 76

Representativeness and Investing 77

Extrapolation Bias 78

Familiarity 80

Familiarity Breeds Investment 81

Local Bias 83

Familiarity Breeds Investment Problems 84

Combining Familiarity and Representativeness Biases 85

Questions 86

Endnotes 86

Chapter 9 Social Interaction and Investing 88

Talking the Talk 89

Imitate Thy Neighbor's Portfolio 89

Social Environment 89

Investment Clubs 91

Investment Club Performance 91

Investment Clubs and Social Dynamics 93

The Media 93

Speed Is Not of the Essence 94

Herding 95

Herding into Stocks 95

"A Rose.com by Any Other Name" 96

Short-Term Focus 96

Faith 97

Social Validation 97

Questions 97

Endnotes 97

Chapter 10 Emotion and Investment Decisions 99

Feelings and Decisions 99

Feelings and Finance 100

Feelings Affect Investment Decisions 101

Sunshine 101

Negative Emotions 103

Optimism 104

Sentiment 106

Market Bubbles 107

The Thrills of Investing 108

Summary 109

Questions 109

Endnotes 110

Chapter 11 Self-Control and Decision Making 111

Short-Term versus Long-Term Focus 112

Controlling Yourself 112

Saving and Self-Control 113

401(k) and IRA Plans 114

Self-Control and Dividends 115

Beating the Biases 116

Strategy 1 Understand the Biases 116

Strategy 2 Know Why You Are Investing 116

Strategy 3 Have Quantitative Investment Criteria 117

Strategy 4 Diversify 117

Strategy 5 Control Your Investing Environment 117

Additional Rules of Thumb 118

Using Biases for Good 119

Save More Tomorrow 119

Save and Win 120

Questions 121

Endnotes 121

Credits 123

Index 124

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Preface

An old Wall Street adage states that two factors move the market: fear and greed. Although true, this characterization is far too simplistic. The human mind is very sophisticated, and human emotions are very complex. The emotions of fear and greed just don't adequately describe the psychology that affects people. This book is one of the first texts to delve into this fascinating and important subject.

Few other texts provide this information because traditional finance has focused on developing the tools that investors use to optimize expected return and risk. This endeavor has been fruitful, yielding tools such as asset pricing models, portfolio theories, and option pricing. Although investors should use these tools in their investment decision making, they typically do not. We tend not to use these tools because psychology affects our decisions more than financial theory does.

Unfortunately, your psychological biases inhibit your ability to make good investment decisions. By learning about your psychological biases, you can overcome them and increase your wealth. You will notice that most of the chapters are structured in a similar way. I first describe the psychological bias and illustrate it with everyday behavior (such as driving a car). The effect of the bias on investment decisions is then described. Lastly, I use academic studies to show that investors really do have the problem.

This material does not replace the investment texts of traditional finance. Understanding psychological biases complements the traditional finance tools. Indeed, after reading this book you should be convinced that traditional tools are valuable.

Read More Show Less

Introduction

An old Wall Street adage states that two factors move the market: fear and greed. Although true, this characterization is far too simplistic. The human mind is very sophisticated, and human emotions are very complex. The emotions of fear and greed just don't adequately describe the psychology that affects people. This book is one of the first texts to delve into this fascinating and important subject.

Few other texts provide this information because traditional finance has focused on developing the tools that investors use to optimize expected return and risk. This endeavor has been fruitful, yielding tools such as asset pricing models, portfolio theories, and option pricing. Although investors should use these tools in their investment decision making, they typically do not. We tend not to use these tools because psychology affects our decisions more than financial theory does.

Unfortunately, your psychological biases inhibit your ability to make good investment decisions. By learning about your psychological biases, you can overcome them and increase your wealth. You will notice that most of the chapters are structured in a similar way. I first describe the psychological bias and illustrate it with everyday behavior (such as driving a car). The effect of the bias on investment decisions is then described. Lastly, I use academic studies to show that investors really do have the problem.

This material does not replace the investment texts of traditional finance. Understanding psychological biases complements the traditional finance tools. Indeed, after reading this book you should be convinced that traditional tools are valuable.

Read More Show Less

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