Behavioral Finance

This is to discuss critically the article ‘Behavioral Finance: Introduction’ as edited by Harrison Hong. The framework to evaluate this article to determine what is the purpose of the editor in making the article and whether he accomplishes said purpose. Hong, attempted to introduce the present literature on behavioral finance. He started with what behavioral finance research has achieved empirically and theoretically.

Thus he admitted the growth of behavioral finance for the last fifteen years given the resulting considerable bodies of both theory and empirical evidence (Hirshleifer, 2001) He used as evidence the capacity to forecast stock returns on the empirical front using a long list of variables. He also mentioned about new datasets that were used in research for better understanding on what are there real determinants of the behavior and performance of investors both locally but also globally (Odean, 1999; Huberman, 2001; Grinblatt and Keloharju, 2000; Hong et al.

, 2001; Guiso et al. , 2004). On the theoretical front, Hong (2007) maintained that the extent of research along three distinct lines including an understanding the reasons for rational businessmen’s failure to completely eliminate the predictability patterns; explanation the specific nature of the patterns of predictability and an examination of corporate managers’ behavior.
On the study of corporate behaviors cited two different directions of research with the first one on resolving the issue whether managerial financing and investment decisions can be understood as rational responses to securities market mispricing ( Baker and Wurgler, 2002) given the established patterns of return predictability. Such is the object of behavioral finance since it could not be assumed the all decisions are rational because of the presence of some factors that may be uncertain or extraneous.
The second is the issue on whether there are effects of nonstandard preferences and judgmental biases on managerial decisions (Baker, Ruback and Wurgler 2004) when managers are not fully rational. This appear that the direction of research is considering all angles which points to growing complexity of unexplained variable in previous researches. In trying to find answers to questions recent researches were conducted for demonstration of the interrelationships among existing models and new datasets, both within behavioral finance and across other disciplines.
Among these include an examination conducted by Peng, Xiong and Bollerslev on how limited attention among investors might generate predictable co-movements of stock prices under their hypothesis that “investors shift their (limited) attention to process market-level information following the arrival of macroeconomic shocks and then subsequently divert their attention back to asset-specific information. ” Another study is the use of new datasets to shed new light on earlier findings in the behavioral finance literature by Barber, Lee, Liu and Odean who had introduce new data from Taiwan to re-examine biases in individual investor behavior.
Hong (2007) reported the latter research to have found evidence on both loss aversion and over-trading on the part of investors in their database, which confirmed earlier results from some of the authors of the said study. Loss aversion is a natural reaction of most investors and hence this could only be confirmatory also of the overriding purpose of financial management which is stockholders’ wealth maximization (Brigham and Houston, 2002) The work of Barber, Lee, Liu and Odean was complemented by a research by Anderson’s using new data from Sweden in studying the behavior of online traders.
Hong (2007) noted Anderson’s dataset covering the period of 1999–2002 to be particularly interesting since the same period represented the peak and subsequent decline of Internet valuations. Nevertheless, Anderson confirmed earlier findings that online investors tend to be young, male and aggressive traders. Anderson too confirmed over-trading like as evidenced by the excessive trading costs. The confirmation of empirical studies by Barber et al.
and Anderson are indeed confirming the use of new datasets in fine-tuning promising theories in behavioral finance. ” Hong (2007) cited also the work of Ghysels, Plazzi and Valkanov on valuation in the US commercial real estate market where the authors examined the predictability of real estate returns whether the same exhibited patterns similar what have been observed in equity markets exists and the researchers found that a certain level commercial real estate prices are better modeled as financial assets much like equities.
Based on the list of researches done on behavioral science, Hong (2007) noted its having matured to the point where its robust early findings are being used to seed exciting new lines of inquiry, both theoretical and empirical. In seeing therefore a natural next step on integrating models of managerial decision to make a more established literature on asset pricing, he essentially challenged future researchers to look into the matter.
But Hong (2007) did emphasize that the promise for more exploration requires the application of equal amounts of discipline to build, to test and refine new theories and datasets. On basis of the of Hong’s presentation of researches and the relationships of one over the other, it may be concluded that he has led the reader into looking for more challenging integration of models of behavioral with other disciplines, which is one of the important part of literature review.
By such standard, the author is deemed to have accomplished his purpose. References: Baker, M. and Wurgler, J. , ‘Market timing and capital structure’, Journal of Finance, Vol. 57, 2002, pp. 1–32. Baker, M. , Ruback, R. S. and Wurgler, J. , ‘Behavioral corporate finance: a survey’, forthcoming in Handbook of Corporate Finance: Empirical Corporate Finance, ed. Espen Eckbo, 2004. Brigham and Houston (2003) Introduction of Financial Management, Thomson-South Western, US Grinblatt, M. and Keloharju, M.
, ‘The investment behavior and performance of various investor types: a study of Finland’s unique data set’, Journal of Financial Economics, Vol. 55, 2000, pp. 43–67. Guiso, L. , Sapienza, P. and Zingales, L. , ‘The role of social capital in financial development’, American Economic Review, Vol. 94, 2004, pp. 526–56. Hirshleifer,D. (2001), ‘Investor psychology and asset pricing’, Journal of Finance,Vol. 56, pp. 1533–97. Hong, H. (2007), Behavioral Finance: Introduction, European Financial Management, Vol.
13, No. 3, 2007, 389–393 Hong, H. and Stein, J. C. , ‘Disagreement and the stock market’, Journal of Economic Perspectives, forthcoming 2006. Huberman, G. , ‘Familiarity breeds investment’, Review of Financial Studies, Vol. 14, 2001, pp. 659–80. Jegadeesh, N. and Titman, S. , ‘Returns to buying winners and selling losers: implications for stock market efficiency’, Journal of Finance, Vol. 48, 1993, pp. 93–130. Odean, T. , ‘Do investors trade too much? ’ American Economic Review, Vol. 89, 1999, pp. 1279–98.