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Psychology of Investing and FinancialDecisions

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Study materials Psychology of Investing and Financial Decisions

Introduction

The objective of this module is to provide a very practical overview of an exciting and high profile new area in financewhich takes as its premise that financial decision making and investor behaviour are not necessarily driven by 'rational'considerations but by aspects of personal and market psychology. Behavioural finance recognises that our abilities tomake complex investment and corporate finance decisions are limited, and that we can improve our performance bothas financial managers and investors by recognising and dealing appropriately with the biases and errors of judgementto which all of us are prone. This module is ideas-based, and conceptual and reflective in nature and draws on yourown experiences. There is no mathematical or statistical analysis involved.

Specifically, this module is designed to introduce you to the basic principles of behavioural finance and its practicalimplications for investors in international capital markets, as well as for corporate financial managers. However, theunderstanding of how we make decisions and how we can improve these by recognising the underlying psychologicalprocesses at work is likely to be of equal relevance not just in other areas of business activity, but in life moregenerally.

The teaching approach is very practical, drawing extensively on your own experience and real world examples anddecisions, as well as using current issues discussed in the financial media as illustrations. Behavioural finance dealswith the psychology of real people making real judgements, and complements the perspective traditional finance takeswhich starts from the premise of economic rationality. Typical questions we will be addressing include such things as:

What are the decision biases to which we are prone?

How do we make (financial) judgements and how can these be improved?

What role do our emotions play?

How should we save for retirement?

Why do private investors lose so much money and how can we avoid this ourselves?

How can we improve our stock and mutual fund selection decisions?

Why are investment analysts buy and sell recommendations so fallible?

Why do fund managers find it so difficult to beat the market?

Why are investors and CEOs so overconfident in their judgements and what are the results?

Why do acquisitions so often destroy value?

How can we improve our capital budgeting decisions and forecasts?

Psychopaths in the boardroom?

By the end of the module the student should be able to demonstrate the following:

Subject knowledge and understanding:

Understand how, by applying behavioural finance, people can become more successful investors andfinancial decision-makers.

Demonstrate a good knowledge of the basic building blocks of cognitive psychology and the role of theunconscious in investing and corporate financial decisions and their implications in practice.

Understand the differences between a behavioural finance perspective and a traditional financeperspective and the limitations of the traditional market efficiency paradigm.

Key skills:

Demonstrate effective written and oral communication skills.

Demonstrate effective team working skills.

Demonstrate developed analytical skills.

Have a very practical understanding of how personal (financial) decisions can be improved.

Page 1 of 3 Warwick Business School

Module outline Psychology of Investing and Financial Decisions

Cognitive skills:

Recognise their own decision errors and understand the reasons for these, so future decision errorsmay be avoided.

Understand why 'real' people are 'irrational' and what this means in the real world of business.

Deal with the competing claims made by both conventional finance and behavioural financeproponents.



Module delivery

The module introduces you to some of the main areas of behavioural finance thinking and is designed to cover someof the most recent developments in the field. The module takes place over five days and is intensive in nature. Itfeatures a combination of taught material, practical exercises, case studies, videos, a visiting speaker, self-study,personal research and class discussion. Teaching is face-to-face, supplemented by a lot of collaborative group work insyndicates. The approach taken is interactive and participative, and includes exploration of current high profileinvestment and corporate financial issues reported in the media. Much of the learning will be generated by participantsdrawing on their own experiences. The key issues will be introduced in the lecture programme. The conceptualelements are reinforced by the use of practical exercises, case studies, videos and classroom discussion. Students onthe module are also required to undertake an element of self-study by completing the exercises and analysing thecases in preparation for the following day's topics and class discussion. Insofar as the module's intensivenature allows they will also conduct their personal reading and review live topics in the financial media.

Prerequisites

Completion of the Accounting and Financial Management core module (IB9030, IB7010, or IB8010) isa prerequisite. This module complements the Corporate Finance elective module (IB9380, IB9370, or IB8100) and Investment and Risk Management module (IB9R40) but can be taken alone.



Monday

Monday 13 April 2015

09.30-10.00 Arrival and Coffee

10.00-11.00 Topic 1: Introduction to behavioural finance

11.00-12.15Topic 2: Formal overview of the psychology of finance decisions:part 1 - heuristics

12.15 Lunch

13.15-14.45Topic 3: Formal overview of the psychology of financial decisions:part 2 - biases

14.45-15.00 Tea break

15.00-16.15 Topic 4: Retail investors: overconfidence and 'the courage of misguided convictions'

16.15-18.00

EVENING

Topic 5: Behavioural finance and the financial crisis (film: The Inside Job)

Preparation of case study 1 (Bill Miller and Value Trust) in groups

All sessions will be taught by Professor Richard Taffler.


Programme Psychology of Investing and Financial Decisions

Tuesday

Tuesday 14 April 2015

09.00-10.00 Presentation and discussion of case study 1

10.00-11.00 Topic 6: Behavioural finance and the professional investor

11.00-11.15 Coffee break

11.15-12.15 Topic 6: Behavioural finance and the professional investor (continued...)

12.15 Lunch

13.15-14.15 Topic 7: Behavioural finance and investment analysts

14.15-15.00 Topic 8: Behavioural finance and alternative investment strategies: hedge funds

15.00-15.15 Tea break

15.15-15.45 Topic 8: Behavioural finance and alternative investment strategies: hedge funds(continued...)

15.45-16.15 Topic 9: Saving for retirement, debiasing and self-control

16.15-17.30 Topic 10: What drives money managers: the view from the inside? (guest speaker)

EVENING Preparation of case study 2 (Rudy Wong, Investment Advisor) in groups



Wednesday

Wednesday 15 April 2015


10.00-11.00 Topic 11: Behavioural finance and market efficiency: stockmarket 'anomalies'


11.15-12.15 Topic 12: Behavioural finance and capital structure decisions

12.15 Lunch

13.15- 14.30 Topic 13: Behavioural finance and IPOs

14.30-15.00 Topic 14: Behavioural finance in capital budgeting

15.00-15.15 Tea Break

15.15-16.00 Topic 14: Behavioural finance in capital budgeting (continued...)

16.00-17.30 Topic 15: Behavioural finance and mergers and acquisitions

EVENING Preparation of case study 3 (Daimler-Chrysler) in groups



Thursday

Thursday 16 April 2015


10.00-11.00 Topic 16: Introduction to emotional finance


11.15-12.15 Topic 16: Introduction to emotional finance (continued...)

12.15 Lunch

13.15-14.00 Topic 17: The 'real' meaning of risk

14.00-15.00 Topic 18: Investing with conviction: the role of storytelling in financial markets

15.00-15.15 Tea break

15.15-16.00 Topic 18: Investing with conviction: the role of storytelling in financial markets (continued...)

16.00-17.15 Topic 19: The vital role of trust in investing

EVENINGPreparation of case study 4 (Facebook IPO) in groups(assessed work)



Friday

Friday 17 April 2015

08.30-10.30 Presentation and discussion of assessed work (case study 4)

Advanced topics in behavioural finance

10.30-11.00Topic 20: Behavioural biases in selection interviews and how to use behavioural finance toadvantage


11.15-11.45 Topic 21: Behavioural biases in group processes: 'groupthink' and 'groupfeel'

11.45-12.30

Topic 22: 'Superstar CEOs':

the role of personality in financial decisions

narcissim and psychopathy

CEO rewards and the role of luck

12.30 Lunch

13.30-15.00Topic 23: Round-up on the psychology of financial decisions in practice: discussion of your ownexperiences in groups and brief presentation

15.00-15.15 Tea break

15.15-16.00 Presentation of what you have learnt on this module and module review



Module assessment

Assessment is by (1) group presentation of a case study (The Facebook IPO) in class in the first session of the lastday of the module (20%), and (2) an individual essay (2,500 words) (80%).

1. Group Presentation (20%)

In respect of your group case study, you will be assessed on the basis of your analysis of the case and application to itof what you have learnt on the module (50%), quality of your presentation (30%) and effective use of group resources(20%). The case will be 'The Facebook IPO' and is attached at the bottom of Thursday's reading page.

2. Individual essay (80%)

Details of the individual essay will be released at a later date.

SUBMISSION DEADLINE: 17.30pm (UK time) 18 May 2015

The submission deadline is precise and uploading of the document must be completed before 17.30 (UK time) on thesubmission date. Any document submitted even seconds later than 17.30 precisely will be penalised for latesubmission in line with WBS policy. Please consult your student handbook on my.wbs for more detailed information.

The online assignment submission system will only accept documents in portable documents format (PDF) files.Please note that we will not accept PDF files of scanned documents. You should create your assignment in yourchosen package (for example, Word), then convert it straight to PDF before uploading. Please place your student IDnumber, NOT YOUR NAME, on the front of your submission as all submissions are marked anonymously.

All the scripts should also have the following paragraph included on the front page:

This is to certify that the work I am submitting is my own. All external references andsources are clearly acknowledged and identified within the contents. I am aware of theUniversity of Warwick regulation concerning plagiarism and collusion.

No substantial part(s) of the work submitted here has also been submitted by me in otherassessments for accredited courses of study, and I acknowledge that if this has been donean appropriate reduction in the mark I might otherwise have received will be made.

PLEASE ENSURE YOU KEEP A SECURITY COPY OF YOUR ASSESSMENT


Assessment Psychology of Investing and Financial Decisions

Teaching faculty

Professor Richard Taffler (Module Cooordinator)- Professor of Finance andAccounting, Warwick Business School

BSc (Econ) (London School of Economics), MSc (London School of Economics), PhD(City), Doctor Honoris Causa (Ghent), Fellow of the Chartered Institute of ManagementAccountants (FCMA), and Fellow of the CFA Society of the UK (FSIP)

Richard Taffler joined Warwick Business School in January 2011 as Professor of Financeand Accounting from a chair at Manchester Business School and is a member of theFinance Group in the School. Previously he was the Martin Currie Professor of Financeand Investment at the University of Edinburgh. An authority on behavioural finance, he haspublished over a hundred academic and professional papers and books, and is frequentlyquoted in the media. Richard's interests include the identification and exploitationof stockmarket anomalies, including the market's inability to deal with bad newsappropriately, fund manager performance and nature of their investment decisions,sell-side analyst judgments, financial distress, the role gambling plays in financial marketsand the impact of CEO overconfidence and narcissism on corporate decisions. ProfessorTaffler is currently developing the new paradigm of emotional finance to complementtraditional and behavioural perspectives and which focuses on the role of the emotionsand unconscious fantasy in explaining investment decisions and market behaviour.Richard consults actively with major investment houses and other financial organisationsand particularly enjoys his MBA and executive teaching and engagement with investmentpractitioners.

Room C2.41Warwick Business SchoolThe University of WarwickCoventryCV4 7ALUnited Kingdomt 024 7652 4153e [email protected]


Teaching Faculty Psychology of Investing and Financial Decisions

Readings

Basic references for each topic are provided. These are short, straightforward, non-technical and 'storybased'. The twocore textbooks for this module are:

Nofsinger, J.R. (2013)The Psychology of Investing (5th edn)London: Pearson Prentice HallISBN: 978 01333 8287 7

Shefrin, H. (2007)Behavioral Corporate FinanceLondon: McGraw-Hill IrwinISBN: 978 007284 865 6

Both are very easy to read and conceptual in nature. Broadly speaking, the first book covers the first part of themodule relating to investor biases and the second, the second part of the module dealing with behavioural corporatefinance.

I will also be making a fair amount of reference to the wisdom of the Nobel Laureate Daniel Kahneman's delightful andentertaining book which is a very easy read full of anecdotes:

Kahneman, D. (2012)Thinking Fast, and SlowLondon: Penguin BooksISBN 978 014 10 3357 0

The third part of the module exploring the new paradigm in behavioural finance, emotional finance, is covered in thebook:

Tuckett, D. and Taffler, R. (2012)Fund Management: An Emotional Finance PerspectiveResearch Foundation - CFA Institute(Downloadable at no cost from the CFA website)

An excellent and very practical new book on behavioural finance, full of investment insights, and entertaining storiesand insights, although not referenced directly in the module, is:

Statman, M. (2011)What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial DecisionsNew York: McGraw-HillISBN: 987-0-07-174165-1

The best more academic book on behavioural finance for our purposes is:

Ackert, L.F. and Deaves, R. (2010)Behavioral Finance: Psychology, Decision-making, and MarketsMason, OH: South-Western Cengage LearningISBN: 978-0-538-75286-2

The readings in this module are divided into pre-readings, essential readings and further readings.

Completing as much of the pre-reading and essential reading as possible before you attend will provide you with awider understanding of the topics to be discussed during the module and therefore enhance your contribution to theclass.

However, we understand that many of you will find it difficult to complete all of the reading due to other commitments,so have classified the readings as follows:

Pre-readings are included in the online materials; you should read these in advance of the session to whichthey relate. Unless specified, you should treat ALL case studies as required pre-reading.

Essential readings are also included in the online materials. In order to complete the module and theassignment successfully you should complete this reading when you have time, either during or after the


Readings Psychology of Investing and Financial Decisions

http://www.cfapubs.org/toc/rf/2012/2012/2

module.

Further readings are intended for those who may wish to widen and deepen their understanding of particularissues now or in the future. You will have to use your own library skills to obtain these.



Pre-reading

Because of the intensive nature of the module there will be little time to do much reading during the teaching week.Therefore I expect you to have done the all the pre-reading for this module - this is required so that you can obtain themost benefit from the module before it starts. Specifically, you will need to have read the following:

The Nofsinger book (150 very easy-to-read pages)

Chapters 1, 3, 4, 5, 6, 9 and 10 of the Shefrin book (again descriptive and conceptual and another 120easy-to-read pages)

Taffler 2001, 'What Can We Learn From Behavioural Finance?'

Eshraghi and Taffler 2012, 'Hedge Funds and Unconscious Fantasy'

Taffler and Tuckett 2007, 'Emotional Finance: Understanding what Drives Investors'

Eshraghi and Taffler 2014, 'Heroes and Victims: Fund Manager Sense-making, Self-legitimation andStorytelling'

Kets de Vries 2012, 'The Psychopath in the C-suite'

If you have time you may also wish to read chapters 4 and 5 (and 6) of the Tuckett and Taffler book (50 pages).Kahneman is also a fascinating, entertaining and very witty "bedtime" read.



Case studies

Case studies from The Case Centre

We are providing links to case studies which have been purchased from the Case Centre and are provided for yourpersonal use on this module, for which you are registered. You may download and print one copy of each for yourpersonal use.

The case studies will expire on 18 May 2015 and will not be available to you after this. We recommend that youdownload them immediately. When you have taken your copy of a case study you may not make further copies, sharethem with or sell the materials to any other person or use them for any purpose not connected with your studies forthis MBA module. Failure to follow these terms and conditions of use may result in disciplinary action.


Preparation of Case Study 1

Case study: Bill Miller and Value TrustRef: UVA-F-1481

Introduction:

Bill Miller is the legendary lead manager of the Legg Mason Value Trust (LMVTX) Mutualfund which was the only mutual fund to beat the S&P 500 each calendar year from 191 to2005. Described by Fortune magazine (28.11.06) as 'the greatest money manager of ourtime', he is frequently compared with Joe DiMaggio the Yankee slugger, who had at leastone hit in 56 successive Yankee games, as having hot hands or being a 'streak shooter'.

Questions:

Discuss the case 'Bill Miller and Value Trust' carefully in your group and answer the followingquestions placing yourself at the time the case was written, i.e., autumn 2005.

How well has Value Trust performed in the years up to the end of 2005 and againstwhich benchmarks?

1.

How do you explain the fund's incredible performance? What role has Bill Miller'sinvestment strategy played in this?

2.

How easy will it be for Miller to sustain his historical performance in the future?3.

4. Suppose you are working as an advisor to wealthy investors in the area of equityinvestments in the autumn of 2005. Would you recommend your clients to invest inMiller's Value Trust? What beliefs about the equity markets does your answer reflect?In particular, prepare a two slide Powerpoint presentation for 9am on Tuesdaymorning of your bullet points to assist you in presenting your short (5 minute) overviewof the main points of your answers.





http://www.thecasecentre.org/programmeAdmin/courses?id=543151&pdid=68435&opid=435739

Case study: Rudy Wong: Investment AdvisorRef: 9B10N004

Questions:

Read the case carefully, then, based on the information provided, discuss answers to thefollowing questions in your groups. In particular, prepare a two slide Powerpoint presentationfor 9am on Wednesday morning of your bullet points to assist you in presenting your short (5minute) overview of the main points of your answers.

How should Wong advise Bob Miller considering Miller's emotional state of mind?1.

How should Miller advise Mary Swanson? Most importantly, should Wong adviseSwanson to shift a large percentage of her portfolio funds from equities to corporatebonds?

2.

How should Wong advise the Kleins?3.

How should Wong advise the Nichols?4.



Case study: The Daimler-Chrysler MergerSee attached at bottom of the page

Questions:

Why did DaimlerChrysler lose so much shareholder value?1.

What is the contribution of behavioural finance to this understanding?2.

In particular, this case provides clear illustrations of the operation of such behaviouralcharacteristics as:

3.

affect

hubris

over confidence

destructive narcissism

over optimism

loss-aversion

self-attribution bias

confirmation bias

reframing etc

Where are these illustrated in this case study?



This case and case work will form part of your final assessment (20%).



http://www.thecasecentre.org/programmeAdmin/courses?id=543152&pdid=93009&opid=435740

Case study: The Facebook IPOSee attached at the bottom of the page

Questions:

The Facebook initial public offering on 18 May 2012 amid much media hype and investorfrenzy was followed by no first day 'pop' and a collapse in share price by over 30% over thefollowing three weeks. The stock had clearly come to the market overvalued and there wereserious criticisms of how insiders had exploited the ' gullibility' of retail investors to get out atan inflated price. This case explores some of the factors that may have been driving thisdebacle and can be considered through the lenses both of emotional finance and investorpsychology.

Read the case carefully, then, based on the information provided, answer the followingquestions in your group. In particular, prepare a short presentation (max. 7 minutes) outliningthe main points of your answers as part of your assessed work (20%). 50% of the marks willbe allocated based on your ability to demonstrate what you have learnt on the module, 30%on the quality of your presentation and 20% on evidence of effective use of group resources.

How has the Facebook share price and sentiment about the company changed sincelate July 2012 and why?

1.

How do you explain the lack of any first day premium and Facebook's subsequentshare price performance to date?

2.

In the lead up to 18 May 2012, what were the dominant factors in people's decisionsto invest, or not, in the Facebook IPO? In your answer, distinguish between rational,behavioural and emotional factors.

3.

What appeared to be driving investor sentiment before and after the IPO?4.

How good was the economic case for investing?5.

Are there any parallels with dot.com mania?6.

With the benefit of hindsight and distance, who do you think was actually at fault andwhat actually went wrong, if anything?

7.


Individual essay, module assignment

Case study:

Questions:

BP and the Deepwater Horizon Disaster of 2010See attached at the bottom of the page

The assessment questions will be added to this page at a later time.



Monday readings


Topic 1: Introduction to behavioural finance

This introductory session provides an overview of, and introduction to, this elective which draws on the new area offinance known as behavioural finance. This is concerned with the psychology of how we make financial decisions andhow such understanding can help improve the quality of the investment and corporate finance decisions we take.Such knowledge is, of course, equally relevant in many other areas of business and personal life. This introductorysession starts by describing the two main families of cognitive information processes we use to make judgements with,the intuitive, or automatic and reflective. It then builds on this understanding to describe what behavioural finance isand why it is so important. It continues by comparing the nature of 'rational' and 'irrational' behaviours and contraststhe tenets of behavioural finance with those of conventional (or traditional) finance and what this means forinvestors, analysts, corporate managers and other financial decision makers. Importantly, a range of areaswhere behavioural finance has particular relevance is reviewed. The basic building blocks of behavioural finance andthe biases present in our decision making processes are then introduced.

Pre-reading:

Taffler, R.J. (2001)'What Can We Learn From Behavioural Finance?'Management Focus, 17, Winter, pp. 8-11

Nofsinger: Chapter 1: 'Psychology and Finance'

Shefrin: Chapter 1: 'Behavioral Foundations'

Topic 2: Formal overview of the psychology of financial decisions:Part 1 - heuristics

This topic formally reviews what the cognitive psychologists tell us about how we make decisions and the biases towhich we are prone. It is divided into two parts. Part 1 defines and then reviews why we have to resort to heuristics orrules of thumb to simplify the financial decision task and then reviews the operation of four key heuristics in practice.Illustrations, applications and implications in a number of relevant and high profile areas are discussed in some detail.Focus is also placed on helping you be in a better position to reduce the potential adverse impact of the operations ofsuch back-of-the-envelope mental short cuts on the financial and other judgements you make and how to exploit theinsights you have gained to enhance the quality of your investment and other financial decisions.

Pre-reading:

Nofsinger: Chapters 2-8

Shefrin: Chapter 1: 'Behavioral Foundations' and Chapter 4: 'Perceptions about Risk andReturn'

Essential reading:

Further reading:

Taffler, R.J. (2010)'The Representativeness Heuristic'Chapter 14 in Baker, H.K. and Nofsinger, J.R. (eds) Behavioral FinanceWiley (supplementary)Please click on 'Myilibrary ebook', and navigate to chapter 14

Kahneman, D. (2012): Part II Heuristics and Biases, chapters 10-18



http://www2.warwick.ac.uk/services/library/search/extracts/ib/ib844e

http://webcat.warwick.ac.uk/record=b2543543~S1

Topic 3: Formal overview of the psychology of financial decisions:Part 2 - biases

Part 2 discusses a range of other information processing and judgemental biases to which we are prone. Again,practical illustrations, applications and implications in a number of relevant and high profile areas are discussed insome detail. Focus is also equally placed on helping you use your understanding of how we make financial and othertypes of decision to improve your investment and financial judgements.

Pre-reading: (As for the previous session on heuristics)

Further reading: Kahneman, D. (2012): Part III Overconfidence, chapters 19-24 and Part IV, chapters26,27,30-34

Topic 4: Retail investors: overconfidence and 'the courage of misguided convictions'

This session describes the impact of overconfidence and other cognitive biases on the performance of individualinvestors. Drawing on empirical research evidence it asks the following questions: What really drives their investmentdecisions? Do they trade too much? Do they have stock picking skills? What impact does gender have? Are investorsreluctant to realise their losses? Do they sell their winning stocks too soon and hold their losers too long? What rolemight mutual funds really be playing for the retail investor? 'Investing' or gambling (lottery players)? Sensationseekers? Why do individual investors invest in the market; social investing and the role of the print and electronicmedia? How can an understanding of behavioural finance help retail investors lose less money?

Pre-reading: Nofsinger: Chapter 2: 'Overconfidence' and Chapter 3: 'Pride and Regret'

Essential reading:

Barber, B.M. and Odean, T. (1999)'The Courage of Misguided Convictions'Financial Analysts Journal, 55, 6 November/December, pp. 41-55

Statman, M. (2002)'Lottery Players/Stock Traders'Financial Analysts Journal, 58, 1, January/February, pp. 14-21

Further reading:

Barber, B.M. and Odean, T. (2011)'The Behavior of Individual Investors'Chapter 22 in The Handbook of the Economics of FinanceFull reference: Barber, B. M. and T. Odean (2013), "The Behaviour of Individual Investors",chapter 22 in Handbook of Economics of Finance (eds. Constantinides, G., H, Harris and R.Stulz), Elsevier, vol. 2B, pp. 1533-1570 (downloadable), or September 2011 SSRN workingpaper available here.

Topic 5: Behavioural finance and the financial crisis (film: The Inside Job)

How did the financial meltdown of 2008 happen costing millions of people their houses, jobs and savings and withcontinuing major ramifications till today around the world? How might the insights of behavioural finance help usunderstand what went wrong?

Pre-reading: Nofsinger: Chapter 12: 'Psychology in the Mortgage Crisis'



http://0-search.ebscohost.com.pugwash.lib.warwick.ac.uk/login.aspx?direct=true&db=buh&AN=2762866&site=bsi-live


http://ssrn.com/abstract=187221

Essential reading: Taffler, R. J. (2014)'Emotional Finance: Theory and Application'WBS working paper 14 October 2014, section 4.2, pp. 21-24See attached at bottom of page



Tuesday readings


Topic 6: Behavioural finance and the professional investor

How can the insights of behavioural finance help explain fund manager performance, what helps drive superior returnsand why does the average manager under-perform the index? The costs of active fund management. Are fundmanagers overconfident? How are mutual funds marketed? How well do 'behavioural' funds perform - doesbehavioural finance work? Professional ('sophisticated') investors v. individual investors ('noise traders')? The real roleof the professional fund manager? Increasing alpha using behavioural finance.

Further reading:

Wright, C.; Banerjee, P. and Boney, V.R. (2008)'Behavioral Finance: are the Disciples Profiting from the Doctrine?'Journal of Investing, 17, 4 (winter), pp. 82-90

Jones, R. C. and Wermers, R. (2011)'Active Management in Mostly Efficient Markets'Financial Analysis Journal, 67, 6 (November-December), pp. 29-45

Topic 7: Behavioural finance and investment analysts

How do sell-side analysts make their stock recommendations and how good are these? What judgemental biases arethey prone to and how does this affect their decisions? The 'good management - good stock' fallacy. Do award winninganalysts really have 'star' quality?

Essential reading:

Mokoaleli-Mokoteli, T.; Taffler, R.J. and Agarwal, V. (2009)'Behavioural Bias and Conflicts of Interest in Analyst Stock Recommendations'Journal of Business Finance and Accounting, 36, 3-4, pp. 384-418(you should skim this only, as it is a somewhat advanced reading)

Further reading:

Bradshaw, M.T. (2011)'Analysts' Forecasts: What Do We Know After Decades of Work?'SSRN working paper (June)

Fogarty, T. J. and Rogers, R. K. (2005)'Financial Analysts' Reports: An Extended Institutional Theory Evaluation'Accounting, Organizations and Society, 34, 4, pp. 331-356

Topic 8: Behavioural finance and alternative investment strategies: hedge funds

What are the main characteristics of hedge funds, what real investment needs are they meeting, why do they implodeso frequently? How can we explain their investment performance? The role of hedge funds in unconscious fantasy.The Bernie Madoff $65bn fraud.

Pre-reading:

Eshraghi, A. and Taffler, R.J. (2012)'Hedge Funds and Unconscious Fantasy'Accounting, Auditing and Accountability Journal, 25, 8, pp. 1,244-65

Essential reading:

Stulz, R. (2007)'Hedge Funds, Past, Present and Future'Journal of Economic Perspectives, 21, 2, pp. 175-94




http://0-dx.doi.org.pugwash.lib.warwick.ac.uk/10.1108/09513571211275461

http://0-search.proquest.com.pugwash.lib.warwick.ac.uk/docview/212073032?accountid=14888

Topic 9: Saving for retirement; debiasing and self-control

Self-control and saving; retirement saving behaviour and enhancing defined contribution (DC) pension plan design;'save more tomorrow'; life-cycle funds; the 1/n heuristic. Strategies to beat behavioural biases: knowing why youinvest.

Pre-reading: Nofsinger: Chapter 11: 'Self-control and Decision Making'

Topic 10: What drives fund manager investment decisions: the view from the inside?

A leading speaker from a global investment banking and institutional securities firm will talk about what his institutionalclients look for when making stock selection decisions and the behavioural biases to which they are often prone.

There is no pre-reading for this session.



Wednesday readings


Topic 11: Behavioural finance and market efficiency: stockmarket'anomalies'

What do we mean by 'market efficiency' in practice? Stockmarket anomalies contradict the efficient market hypothesis(EMH) and suggest, if they are robust, that it is possible to make money by following trading strategies designed toexploit them. Investor irrationality due to cognitive bias is often adduced to explain their existence. This topic brieflylooks at what constitutes a potential market anomaly and which ones might be potentially exploitable. It then considershow the insights of behavioural finance may help explain these, and also whether trading costs and barriers toarbitrage inhibit their exploitation in practice. Importantly, the session compares bad news anomalies versus goodnews anomalies and explores the role of 'loss aversion'. Are markets 'rational' rather than 'efficient'?

Pre-reading: Shefrin: Chapter 5: 'Inefficient Markets and Corporate Decisions'

Further Reading: Rubinstein, M. (2001)'Rational Markets: Yes or No? The Affirmative Case'Financial Analysts Journal, 57, 3, May/June, pp. 15-29

Topic 12: Behavioural finance and capital structure decisions

Financing the firm: the debt/equity decision. The differing perspectives of traditional finance and behavioural corporatefinance. The capital structure decision in theory and what managers do in practice: target capital structure versuspecking order theory. The role of managerial optimism, overconfidence and personality.

Pre-reading: Shefrin: Chapter 1: 'Behavioral Foundations' and Chapter 6: 'Capital Structure'

Topic 13: Behavioural Finance and IPOs

Initial public offerings (new issues) - the decision to go public. Initial underpricing and long-termunderperformance. Hot issue markets. The technology bubble. Valuing an IPO: behavioural biases at work? A numberof IPO cases will be discussed.

Pre-reading: Shefrin: Chapter 5, section 5.6 only: 'To IPO or Not to IPO?', pp. 82-9

Topic 14: Behavioural finance in capital budgeting

This session explores the contribution of behavioural finance to issues in investment appraisal. Itspecifically recognises the role psychological factors play in capital investment decisions in contrast to whattraditional corporate finance theory argues. The behavioural finance perspective views such decisions as beingprone to a range of cognitive and emotional biases including overconfidence, overoptimism, loss aversion, wishfulthinking, avoiding regret and not ignoring sunk costs, etc., leading to value destructive decisions in practice in violationof conventional investment appraisal techniques. The important implications of the operation of such biases for projecttermination and managerial entrapment in losing projects are also explored. Practical ways of debiasing managerialforecasts are also discussed.

Pre-reading: Shefrin: Chapter 3: 'Capital Budgeting'

Essential reading:

Shefrin, H. (2001)'Behavioral Corporate Finance'Journal of Applied Corporate Finance, 14, 3, Fall, pp. 113-24



http://papers.ssrn.com/sol3/papers.cfm?abstract_id=288257

Topic 15: Behavioural finance and mergers and acquisitions

This topic explores the contribution of behavioural finance in understanding corporate acquisition activity and whysuch deals continue to be so common when they are typically bad news for acquiror shareholders. It also exploreswhy acquiring firm managers typically overpay and the role of hubris or managerial overconfidence and narcissism inexplaining such value destroying behaviours. A range of examples will be discussed in some detail.

Pre-reading: Shefrin: Chapter 10: 'Mergers and Acquisitions'

Essential reading:

Shefrin, H. (2001)'Behavioral Corporate Finance'Journal of Applied Corporate Finance, 14, 3, Fall, pp. 113-24Note: You should already have downloaded this paper for Topic 14




Thursday readings


Topic 16: Introduction to emotional finance

The powerful unconscious forces that drive all financial activity have not yet been properly acknowledged in thefinance literature. Emotional finance, a new direction in behavioural finance, draws on the rich insights of over ahundred years of psychoanalytic study of the human psyche to help us understand more systematically howunconscious needs, fantasies, fears and drives influence investment and financial decisions more generally, andmarket behaviours.

In this session we explain what emotional finance is and describe some of the underlying theory and how this can helpus understand investor and market behaviour better. Particular areas to be addressed include the different states ofmind in which financial decisions can be made, and corresponding issues of trust and distrust; informationasymmetries and associated anxiety; the crucial emotional dimensions of uncertainty and risk; the powerfulunconscious meaning of loss and associated mental defences, and its implications for all financial decision making,the unconscious representation holding stocks (and other assets) has for us as 'phantastic objects', and thepsychodynamic behaviour of groups. This understanding will then be applied to a number of issues not well explainedby traditional finance and behavioural finance including the role of the fund manager and nature of the fundmanagement industry. The session will conclude with an explanation of the role unconscious fantasy plays inexplaining asset pricing bubbles, including dot.com mania and the recent Chinese stockmarket bubble, as well asproviding a cogent explanation for, and etiology of, the global financial crisis and current economic policies in Europe.

Pre-reading:

Taffler, R.J. and Tuckett, D.A. (2007)'Emotional Finance: Understanding what Drives Investors'Professional Investor, Autumn, pp 18-2 0

Essential reading:

Tuckett, D. and Taffler, R.J. (2012)'Using Emotional Finance to Understand the Asset Management Industry'Chapter 6 in Fund Management: An Emotional Finance PerspectiveResearch Foundation: CFA InstituteSee attached at the bottom of the page

Taffler, R.J. (2014)'Emotional Finance: Theory and Application'WBS working paper 14 October 2014, section 4.2, pp. 21-24See attached at bottom of page

Further reading: Bellotti, X.; Taffler, R.J. and Tian, L. 'The Chinese Stockmarket Bubble'WBS working paper, February, 2012See attached at bottom of page

Topic 17: The 'real' meaning of risk

Risk and return. Conventional measures of risk and the Capital Asset Pricing Model (CAPM). Behavioural biases.Risk, uncertainty and anxiety. The emotional finance perspective: 'real' risk measures or only pseudo-defencesagainst uncertainty. Information asymmetry, unpredictability, business risk and career risk. How asset managers dealwith real risk.

Pre-reading: Shefrin: Chapter 4: 'Perceptions about Risk and Return'



http://www2.warwick.ac.uk/services/library/search/extracts/ib/ib844e

Essential reading:

Tuckett, D. and Taffler, R.J. (2012)'Dealing with Risk, or What Can Go Wrong'Chapter 5 in Fund Management: An Emotional Finance PerspectiveResearch Foundation: CFA Institute

Topic 18: Investing with conviction: The role of storytelling in financial markets

How do fund managers make investments when outcomes can't be predicted? Sense making in finance and the roleof storytelling. Narratives, stories and plots. The role of emotion. Success stories and stories for when things go wrong:epic, tragic, romantic and comic story types. Traditional fund manager and quantitative fund manager stories.Reporting to investment clients.

Pre-reading: Eshraghi, A. and Taffler R.J. (2014)'Heroes and Vicitms: Fund Manager Sense-making, Self-legitimation and Storytelling'Warwick Business School Working paper (18.9.2014)See attached at the bottom of the page

Topic 19: The vital role of trust in investing

Fund managers are expected to outperform on a consistent basis in an uncertain and unpredictable world and have toenter into emotional relationships with their investments which can easily let them down. To generate the conviction tobe able to invest when outcomes are unknowable they have to trust, typically company management, both to providethem with the information they need without being misled and also to 'perform'. Trust and investing are synonymous.Why is meeting management so important to fund managers; what is their role in alleviating the anxiety of uncertaintyand do such meetings have investment or only psychic value?

Essential reading:

Roberts, J.; Sanderson, P.; Barker, R. and Hendry, J. (2006)'In the Mirror of the Market: The Disciplinary Effects of Company/Fund ManagerMeetings'Accounting, Organizations and Society, 31, 3, pp. 277-94



http://www.cfapubs.org/toc/rf/2012/2012/2

http://0-www.sciencedirect.com.pugwash.lib.warwick.ac.uk/science/article/pii/S0361368205000073

http://0-www.sciencedirect.com.pugwash.lib.warwick.ac.uk/science/article/pii/S0361368205000073

Friday readings


Topic 20: Behavioural biases in selection interviews and how to use behavioural finance to advantage

'With the possible exception of such obvious forms of quackery as graphology, phrenology and astrology, no otherpersonnel selection technique is held in as low esteem in the research literature as the interview' (Dipboye, et al.,1984). The job interview is a social process and bias in intrinsic to the interview procedure. In this session we explorethe nature of the behavioural biases manifest and describe how to deal with these effectively in interview situations.Implications for fund manager selection are drawn.

Further reading:

Macan, T. (2009)'The Employment Interview: a Review of Current Studies and Directions for FutureResearch'Human Resource Management Review, 19, 3, pp. 203-18

Topic 21: Behavioural biases in group processes: groupthink and 'groupfeel'

What happens in group decision making? Successful groups v. destructive groups: groupthink; ' groupfeel' andunconscious group processes: work groups and basic assumption groups; markets as large groups. The dark side ofgroups: Enron.

Pre-reading: Shefrin: Chapter 9: 'Group Process'

Topic 22: 'Superstar CEOs': The role of personality in financial decisions; narcissism and psychopathy;CEO rewards and the role of luck

Traditional behavioural finance views decision errors or 'irrational' behaviour as being explained by the operation ofcognitive heuristics and biases whereas emotional finance looks to the role of the unconscious in explaining financialbehaviours. However, the contribution of individual personality issues and particularly such under-acknowledgedpersonal characteristics as narcissism and psychopathy in explaining destructive managerial, investment banking andother investment behaviours is often overlooked. This topic explores such issues and their implications for firm value. Italso discusses how to deal with such 'difficult' people typified, for example, by Fred Goodwin at The Royal Bank ofScotland or Richard Fuld at Lehman Brothers. This session also discusses the role of chance in explainingCEO performance and the behavioural perspective on director pay without performance.

Pre-reading:

Kets de Vries, M.F.R. (2012)'The Psychopath in the C Suite: Redefining the SOB'INSEAD Faculty & Research Working Paper 2012/119/EFE

Essential reading:

Stein, M. (2013)'When does Narcissistic Leadership Become Problematic? Dick Fuld at LehmanBrothers'Journal of Management Inquiry, 22, 3, pp. 282-93

Further reading:

Bebchuk, L.A. and Fried, J.M. (2005)'Pay without Performance: Overview of the Issues'Journal of Applied Corporate Finance, 17, 4, pp. 8-23

Babiak, P. and Hare, R.D. (2007)Snakes in Suits: When Psychopaths go to WorkLondon: HarperCollins




http://0-jmi.sagepub.com.pugwash.lib.warwick.ac.uk/content/22/3/282.full.pdf+html

http://0-jmi.sagepub.com.pugwash.lib.warwick.ac.uk/content/22/3/282.full.pdf+html

ISBN: 9780061147890(A riproaring good read which is also highly instructive!)



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