32
mation are overvalued in contrary to long term
fundamental data. Furthermore, the perfor-
mance of a single investment is compared with
the performance of total markets and not based
to absolute return aspects.
Mental Accounting
describes the process of
evaluation information based on individual re-
cognition patterns of investors based upon indi-
vidual preference factors like risk return relati-
onships. Herein,
Narrow Framing
refers to the
decision situation that often neglects alternati-
ve investment opportunities to a given offer. In-
vestors psychologically separate total wealth
into “mental accounts” with different buckets
and pools of assets and risks. But investors pay
less attention to the relationship between the
different investments in different mental ac-
counts. This behaviour is in contrary to the
classic portfolio theory.
Ambiguity Aversion
refers to the situation that
representative and objective distribution proba-
bilities of a decision are often not available.
Therefore, investors often apply subjective esti-
mations of such probabilities that are based
upon their individual and subjective utility prefe-
rence although being mostly wrong. It is empi-
rically proved that investors charge a relatively
high risk premium for long term equity invest-
ments. This effect is named as
Myopic Loss
Aversion
and part of the so called
Equity Pre-
mium Puzzle
. Furthermore, the value and the
yield of stock investments are more volatile
than their annualized dividend yield – named as
so called
Volatility Puzzle
.
or risk free profits to higher uncertain profits. In
situations with negative markets prospects, in-
vestors however prefer an uncertain high loss
to a certain lower loss. This means that the uti-
lity/value function of profits (positive area) is de
facto concave and for losses (negative area)
convex, leading to a S-shaped functional curve.
This behaviour is related to the so called En-
dowment Effect. Investors appreciate the value
of an up to date certain wealth compared to
possible future uncertain wealth with higher
possible value. A certain profit of 100 € is pre-
ferred to an uncertain profit of 1.000 € with an
estimated probability of 10% or alternatively 0 €
with a probability of 90%, although both alter-
natives lead to the same expected value of 100
€. This behaviour is described by a so called
Weighted Probability Function, measuring the
objective probability on the axis of abscissae (x-
axis) and the subjective/individual probability
on the axis of ordinate (y-axis). The decision
process consists of the two steps editing and
evaluation. Possible future results are estima-
ted by heuristics that lead to profit/loss biased
(“subjektiv und kognitiv verzerrte”) distribution
density functions. This S-based value function
is asymmetric with a reference point P at the
source (0/0). The Prospect Theory is more a
description model than a solution model, be-
cause the subjective prognosis of future profit/
loss distributions and biases is not a valid value
of the ex-post de facto results.
Framing
describes the effects of the presenta-
tion of information. Extraordinary or unusual in-
cidents as well as actual and near term infor-
Optimism, Wishful Thinking and Overconfi-
dence
describe the overestimation of investors
into their own abilities and expertise. In practi-
ce, most investors underestimate the volatility
of markets and prices measured by statistical
distribution models of normal density functions
and value at risk models.
Representativeness
describes the solution of
complex models and situations by the applica-
tion of so called heuristic procedures that only
provide “a good guess“ than a substantially sta-
tistical and reliable calculation. Distribution bias
and the validation of samples are often not ap-
propriate to reality.
Conservatism
describes the effect that inves-
tors more often rely onto their own judgements
in situations they are unsure of the de facto dis-
tribution of market prices under uncertainty
and volatility. Furthermore, the so called histo-
rical volatility is not a valid estimation of the fu-
ture volatility and can significantly differ from
the up to date “implied“ volatility. A conservati-
ve, risk avoiding basic investment strategy of-
ten leads to market underperformance, under
estimating the growth and underestimating
profit potential of “uncertain” new technologies.
Belief Perseverance and Confirmation Bias
illustrate that investors more often stick to their
once made market decisions and prognosis
and refuse to change their attitude although si-
gnificant market signals should lead to a funda-
mental review of future evaluations. This beha-
viour is as well named as inertia. Therefore, in-
vestors often miss a kind of “strict line” or auto-
matism of correction their investment decisions.
The
Prospect Theory
(“Neue Erwartungstheo-
rie”) of Kahneman and Tversky is an empirical
based model for decision making under uncer-
tainty/risk. Individual risk behaviour and subjec-
tive utility preferences are related to estimated
future distribution biases. Their investment be-
haviour is risk averse. The Prospect Theory is
therefore a so called preference model that
evaluates future expected gains and losses with
a different shape of investors value, utility and
preference, in which a possible risk in profit
scenarios is undervalued while the risk of los-
ses is often overvalued. In situations with posi-
tive market opinions investors prefer lower risk
Autoren
Dipl.-Kfm. Dr. Michael Pietrzak
graduated in Banking and Finance in Münster and Stuttgart Hohen-
heim and is Co-Head of Management of Rating & Risk Consulting
GmbH Berlin. He formerly worked for Deutsche Bank AG, Deutsche
Börse Group, Schultze & Braun GmbH and BaFin Bonn. He is fur-
thermore lecturer for Controlling, Accounting and Finance with
several universities in Germany.
E-Mail:
Dipl.-Kfm. Karl-Heinz Bächstädt
is Certified Rating Advisor, Certified Lean & Six Sigma Black
Belt, Certified IT-Tester and works as Management Consultant
and Managing Director at Rating & Risk Consulting GmbH, Berlin.
E-Mail:
Behavioural Finance
