Financial Engineering Brought to You by Engineers

most of which are human.

I saw this in the NY Times… and here is says from the WSJ but in any event, the word is out. Math wizzes are human. The human brain does funny things with biases and predispositions that causes it to not see the data clearly.

In fact, one solution to this is to always assume that we are being biased and where the bias is and how can it hurt us? Where is the emotional attachment to the current “viewpoint” and how can that be a risk?

THAT is part of psych cap and the coming paradigm for comprehensive risk management.

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  1. The human brain does funny things with biases and predispositions that causes it to not see the data clearly.
    ———————————————————————————————–
    Indeed, the stock market is a perfect example, for example, how investors are overconfident about their abilities, their knowledge, or their future prospects or are often overconfident in their abilities to pick winners. They don’t diversify enough—and they buy and sell too often, taking profits too early, and eat into their gains by running up unnecessary trading costs. They do all of that funny things, just to end up with underperformance down the road. it is not much of a strategy too. Often, we are being biased.

    Here’s an interesting research paper:
    Boys will be Boys: Gender, Overconfidence, and Common Stock Investment

    Brad Barber and Terrance Odean
    Abstract
    Theoretical models of financial markets built on the assumption that some investors are overconfident yield one central prediction: overconfident investors will trade too much. We test this prediction by partitioning investors on the basis of a variable that provides a natural proxy for overconfidence – gender. Psychological research has established that men are more prone to overconfidence than women. Thus, models of investor overconfidence predict that men will trade more and perform worse than women. Using account data for over 35,000 households from a large discount brokerage firm, we analyze the common stock investments of men and women from February 1991 through January 1997. Consistent with the predictions of the overconfidence models, we document that men trade 45 percent more than women and earn annual risk-adjusted net returns that are 1.4 percent less than those earned by women. These differences are more pronounced between single men and single women; single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are 2.3 percent less than those earned by single women.
    http://faculty.haas.berkeley.edu/odean/papers/gender/gender.html

  2. The human brain does funny things with biases and predispositions that causes it to not see the data clearly.
    ———————————————————————————————–
    Indeed, the stock market is a perfect example, for example, how investors are overconfident about their abilities, their knowledge, or their future prospects or are often overconfident in their abilities to pick winners. They don’t diversify enough—and they buy and sell too often, taking profits too early, and eat into their gains by running up unnecessary trading costs. They do all of that funny things, just to end up with underperformance down the road. it is not much of a strategy too. Often, we are being biased.

    Here’s an interesting research paper:
    Boys will be Boys: Gender, Overconfidence, and Common Stock Investment

    Brad Barber and Terrance Odean
    Abstract
    Theoretical models of financial markets built on the assumption that some investors are overconfident yield one central prediction: overconfident investors will trade too much. We test this prediction by partitioning investors on the basis of a variable that provides a natural proxy for overconfidence – gender. Psychological research has established that men are more prone to overconfidence than women. Thus, models of investor overconfidence predict that men will trade more and perform worse than women. Using account data for over 35,000 households from a large discount brokerage firm, we analyze the common stock investments of men and women from February 1991 through January 1997. Consistent with the predictions of the overconfidence models, we document that men trade 45 percent more than women and earn annual risk-adjusted net returns that are 1.4 percent less than those earned by women. These differences are more pronounced between single men and single women; single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are 2.3 percent less than those earned by single women.
    http://faculty.haas.berkeley.edu/odean/papers/gender/gender.html

  3. Interesting report. What immediately comes to mind though, is the true level of risk taken by the different groups surveyed.
    I would be glad to achieve lower returns, and trade 145% more…. if I never went to bed with a trade open. Because at the end of the day, all my positions are closed… and I have 0 exposure.

    Good Trades,

  4. Interesting report. What immediately comes to mind though, is the true level of risk taken by the different groups surveyed.
    I would be glad to achieve lower returns, and trade 145% more…. if I never went to bed with a trade open. Because at the end of the day, all my positions are closed… and I have 0 exposure.

    Good Trades,

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