Archive for the ‘Psychology’ category

End of Behavioral Finance

endofbihavioralfinance

I really don’t know why Richard Thaler chose this headline for a research paper. Many other behavioral finance academic papers also capture attention. “Can the markets add and subtract?”; “The winner’s curse”; “The gambler’s fallacy”, “Does the stock market overreact?” While the popularity of the subject has increased and behavioral biases have got so pervasive that everybody seems to be biased, the question is whether the behavioral finance experts are bias free?

Deviation

Behavioral finance is a subject built around price anomalies. Anomaly is a deviation or departure from the normal. Prices tend to deviate from normal most of the time. Markets tend to overvalue or undervalue asset prices more often than staying at fair value. So whether it is stock markets diverging from the real economy, performing sector diverging from an underperforming sector, it all boils down to divergence. This idea of deviation, departure or divergence can be extended from markets to nature. A low paying job vs. a high paying job, lot of rain compared to drought, magnetic anomalies, divergences are all over the place.

Are these deviations different?

Well statistically speaking; no. But psychologically speaking; yes. It’s not the task of behavioral finance experts to look for transcending rules across areas of study be it psychology or nature. Many time thinkers are so focused on “pattern seeking” that the big picture eludes them. And whose job is it anyway, to look for common rules across nature? Even Mandelbrot, who could have pushed himself for connecting diverse areas, concluded that it was all geometry, there was no law. I disagree with Mandelbrot and the Behavioral school of thought. I am with the statisticians. They are the one who look at deviations, departures as errors and they are the ones who identified that fat tails were more normal than irregular. So if diversions are a reality across nature, than is behavioral finance not getting ahead of itself by basing every stock market departure as owing to psychology and ignoring rest of the natural divergences?

The academic paper in question…

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Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


Gamblers of New York

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I don’t see gamblers around here in New York. I wonder where Behavioral finance saw them and how they coined the term Gambler’s fallacy. At the Market Technicians Association Annual Symposium it seemed business as usual. The panel was figuring out the future of markets and the future of technical analysis.

Dr. Andrew Lo, professor of Finance MIT wrote “Non Random walk down wall street”. He believed technicians played a key role in the evolution of research and in pattern recognition. The future of technicals rested in a combined approach of fundamentals, technicals and quants. Andrew shared his personal journey and the resistance he faced when he was disproving efficient market hypothesis. He tested price volatilities for different time frequencies to prove that markets were in-efficient. He talked about adopting a more scientific approach to markets. Even Herbert Simon mentioned that complexity was intrinsically simple and hierarchal. Could it be possible that markets had just one DNA pattern, say a snowflake or head and shoulder, which mirrored and created every other pattern? Could such a pattern singularity in markets be probable?

To read the complete article visit Business Standard or subscribe to the Time Triads Newsletter

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


India Worst 20

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When it comes to investing, there is no doubt that India is more active than passive. Ofcourse the new money, the news channels and internet has taken trading home to my aunt and other South Delhi modern influential decision making house wives. This is all good; the problem is about giving up before you even started. Just because there is no formal induction to stock markets, Reliance does not go up or futures turned out sharper than the kitchen knife should not be the reasons to give up. What if you were using the wrong investing style?

Anything which could be reviewed quarterly and more could be considered passive. This could be academically debated, but we are talking about an investing style evolution and taking investors and investing in India to the next stage. Regarding, what is better “passive” or “active”? Actually it’s more about your risk profile (you are either active or passive, not both). However, historically short term traders are known to underperform intermediate and longer term investors.

In any case with nearly a million Indices globally and more than 30,000 ETF’s worldwide, India’s passive scene is dismally underplayed. We need more passive instruments, if we have to increase market sophistication, liquidity, choices and investor awareness. The new 25 NSE Sector indices was a much awaited initiative. Thinking sectorally is a first step towards passive style investing. More benchmarks could mean more ETFs, which would then become a virtuous cycle. We won’t trade ETFs like we trade NIFTY futures, hence a key passive step.

Why did we not think of passive earlier?…

To read the complete article visit Business Standard or subscribe to the Time Triads Newsletter

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


Life of “Average” - I

Just like we don’t need to understand inflation for it to trouble us, we really don’t need to be able to spell statistics for it to rule us. The realization of an average lifespan could have pushed many saints towards the spiritual path, but for us simple material investors, our life moves around a statistical average.

What is a statistical average? Starting from the average salary, to the average rate of monsoon,  to the average run rate of MSD, to the average of DOW Jones Indices, averages are not only ubiquitous but they are part of popular psyche. Now this is where the problem begins. You can take a man out of Delhi, but you cannot take Delhi out of him. Habits are hard to change. And these habits are generational. How could we first understand something intrinsic, then challenge it and then eliminate it. It’s an impossible feat. Average is a part of societies erroneous functioning.

Before we see “why”, let’s dig in a bit of etymology. An early meaning of the word average is “damage sustained at sea”. An average was about assessing an insurable loss linked to a damaged property. Strangely our case against the average here too is about how anchoring on an average is a loss making proposition for the economic man, even today.

Why erroneous? “Nature was never about equality, it was always about proportion. If weather over the long term does not have an average, the idea of average return for the stock market is redundant”. Society loves status quo and hence the benchmarks that come with it. We are in love with the average because of the comfort we get from them.

Reality is far diverging from an average…

To read the complete article visit Business Standard or subscribe to the Time Triads Newsletter

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


Wish, intution and counterintuition

A friend asked me how I could differentiate my wish from my intuition. She made me think, how there was a thin line when it came to defining what we wish and what we assign a certainty too; an intuition. The human thinking was based on subjective patterns, which either we understood (intuition), or wished to comprehend.

Intuition was a system, a crude cognitive system, which every one of us needed to live. Coming to think of it, we could not have built Indices and portfolio systems, if it was not for the intuition we developed over a decade of what works and what does not.

We pondered on the subject together a bit and debated how wish was connected with interest, an opaque frame. The frame forced us to be judgemental, taking us away from our ability to measure and compare. And when we could not measure, we were away from intuition, but closer to a wish, overconfident of a desired result.

In their paper on ‘Predictably Incoherent Judgments, Sunstein (Harvard Law), Kahneman (Princeton), Schkade (University of California) and Ritov (Hebrew University of Jerusalem), talk about cognitive biases and how poor ability to compare makes societal intuition poor.

Even if the moral intuitions and sentiments of individuals could be rationalized…

You can read the complete article in Business Standard

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


The Vicious Forecast

It took me a long time to learn that instruments and forecasts don’t make money, risk management does. If you are in capital markets, forecasting is paid work, a job, a vocation. Predictions are all over the place. What’s a prediction? Euro will die or Nifty will reach 8,000 or Gold will rise are all predictions. “That new Tom Cruise film will be a hit.” Whenever we say “will”, we attach a 100% probability to the event. A lot of times I ask, “How can you be 100% sure?”

Is there a way to outperform the market and not use a prediction? Well we may not have cured ourselves from the forecasting passion (or vice) yet, but as we move towards systems, the only forecast we would like to do is that performance is cyclical and the worst performers of yesterday become the winners of tomorrow. This phenomenon of reversion is not a prediction or a forecast, but a visible reversion seen in outliers. But then what should we do about our need to forecast or follow our intuitions.

According to Daniel Kahneman, “Following our intuitions is more natural and somehow more pleasant, than acting against them it’s natural to generate overconfident judgments because confidence, as we have seen is determined by the coherence of the best story. However, we are not all rational, and some of us may need the security of distorted estimates to avoid paralysis. If you choose to delude yourself by accepting extreme predictions, however, you will do well to remain aware of your self-indulgence.”

So much we suffer from forecasting that we just can’t leave an opportunity to predict. ..

You can read the complete article in Business Standard

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


Love Thy Nifty


From start of the year a business TV program editor wrote me numerous mails to have me as a market commentator during my next visit to London, Delhi or New York. And after I finally made it to the hot seat, it turned out to brief affair.

TV Host” Mukul what is your view on the market?
MP: “We are long on the market”
TV Host” Why is that so?
MP: “Because Indian markets have underperformed its global peers and this underperformance should reverse and lead to performance”

And it was over. It took me a while to realize that our work on mean reversion did not generate causal explanations. The mind is strongly biased towards causal explanations and does not deal well with “mere statistics”. There is an insistent demand for causal interpretations. When our attention is called to an event, associative memory looks for its cause and causal explanations are evoked whenever regression is detected.

According to Daniel Kahneman (Nobel Prize 2002), humans love this narrative causality. “However, the explanations are wrong because regression to the mean might have an explanation but it has no cause.” Regression is a temporal event.  In his book ‘Thinking fast and slow’, he explains mean reversion and how society pays people quite well to provide interesting explanations of regression effects. A business commentator who correctly announces that “the business did better this year because it had done poorly last year” is likely to have a short tenure on the air. The phenomenon of regression is strange to the human mind. Simply putting mean regression suggests that “what goes up comes down and vice versa.”

It’s this love for narrative causality that keeps us hooked to the “love thy Nifty” spell, so much so that the talk of Nifty and 5,000 can be an endless market saga.

You can read the complete article in Business Standard

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


The Crazy Consumption

 

Most of the time we make a buy or a sell case, rarely do we look at stock market trends from a consumption point of view. Markets work with a multitude of external factors, consumption is one of them. But if the broad consumption trend is up, the society will not just gobble up cars, burgers and films, it will also gulp down stocks and investment ideas.

But then one may say that such connections are not linear, consumption is also about basic needs. Out of the 10 broad economic sectors around half are linked with direct societal consumption. The consumer discretionary sector includes stocks that sell products (or offer services) that consumers do not necessarily need (like consumer staples), but that they want. The consumer discretionary includes auto related, entertainment, home appliances, homebuilders, retailers etc.

Auto, FMCG, BSE Consumer Durables were the top performers since 2009. And this has not been just an isolated case for India. Even globally the consumer discretionary or retail ETF SPDR is the top performing sector. This means that society is not only consuming, it’s on a consumption spree.

A society does not consume because …

This article was written for Business Standard

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Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


The Rational Exuberance

 

In the age of information, quotes become books and books become religion, almost. Robert Shiller’s Irrational Exuberance was a voice of caution that appeared in March 2000, before the start of a decade long sequence of negative fluctuations. The book itself was written about economic bubbles and investor psychology.

Shiller’s based his work on his 1981 research paper in the American Economic review, where he showed the divergence between fundamentals and market prices. He took the present value (PV) of dividends paid on S&P composite stock price index discounted by a constant real discount rate for the period (1871-2002). He illustrated that PV behaves remarkably like a stable trend. In contrast, stock price index gyrates, wildly up and down around this trend. Shiller’s contention was that the divergence was much larger than what valuation could explain. Price change was driven by psychology not by fundamentals. He suggested feedback dynamics between human interactions as the explanation for excessive volatility or bubbles.

Who owns the truth?

On one side Shiller and other new age experts highlighted the weakness in the assumption of efficiency, but on the other hand was it correct to swing to total irrationality (inefficiency)? Why could we not give benefit of doubt to earlier thoughts on rationality (normality)? After all there were no tera-bytes of data and real computing power. In hindsight the rationalist argument might have gaps, but how do we think tomorrow would judge the “irrationalists”?

A recent award winning paper by David N. Esch in the Journal of Investment Management addresses the…

This article was written for Business Standard

Mail us for subscription details or download the report from our Reuters store.

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


Investing like Odysseus

Odysseus has traditionally been viewed in the Iliad as Achilles’ antithesis. Unlike Achilles whose anger is self-destructive, Odysseus is renowned for his self-restraint and diplomatic skills.

While passing through the land of sirens, known for their luring fatal songs, he orders his men to stop their ears with beeswax and ties himself to the mast of the ship. Recognizing that in the future he may behave irrationally, Odysseus limits his future agency and binds himself to a commitment mechanism (i.e. the mast) to survive this perilous example of dynamic inconsistency.

In economics, dynamic inconsistency, or time inconsistency, describes a situation where a decision-maker’s preferences change over time in such a way that what is preferred at one point in time is inconsistent with what is preferred at another point in time.

A simple analogy to investing and time preference would be trading gains and losses. It has been observed that that the investing community is more eager to cut out gains faster than a similar amount of loss. This can be explained from a temporal perspective also. When choosing between $100 or $110 a day later, individuals may want to wait a day for an extra $10. Yet after a month passes, many of these people will reverse their preferences and now choose the immediate $100 rather than wait a day for an additional $10.

The eagerness to consume, or instant gratification compared to deferred gratification is what differentiates the investing majority from the Odysseus minority. Investing is a lot about self restraint. Humans give more importance to today compared to tomorrow, the idea of “now” is more important than to the idea of some distant time in the future.

Temporal discounting refers to the tendency of people to …

This article was written for Business Standard

Mail us for subscription details or download the report from our Reuters store.

Mukul Pal, is a Chartered Market Technician, MBA Finance and a member of the reputed Market Technicians Association (MTA). He has more than a decade of Capital Market experience dealing with derivatives and global assets. He has worked for Bombay Stock  Exchange, multinational Banks and brokerage houses in leading research positions before starting on his own in 2005. He is the President of the MTA Central and Eastern European Chapter.


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