Behavioural finance

What can behavioural finance bring to the understanding of markets?

For many years, economical researches have been enriched by a psychological dimension, thanks to the work that has been done by many researchers, such as professors Werner de Bondt, Richard Thaler or Daniel Kahneman and Vernon Smith, rewarded by the Nobel Prize in Economics in 2002.

When analysing both individual and and collective behaviour towards stock exchange values, the behavioural approach explains phenomenons that are struggled to be defined by efficient markets theories.
Researchers gathered evidence of the individual’s irrationality and pointed out that this irrationality can explain observed markets deficiencies.

Over-performance of shares against bonds and other kinds of assets classes, can be justified by inherent rights when owning a company.
These ownership rights enable to take part in wealth creation, while foreign funds compensation is generaly fixed and time-limited.
However, shares give rise to risk premiums, despite a historically established over-performance against bonds, for instance.
Those risk premiums vary over economical and financial cycles, but never disappear.

Behavioural finance provides useful insights toward those risk premiums changes.
This equity structural risk premium is explained by three combined factors:

  • loss aversion
  • short vision (investment horizon often not longer than one year)
  • individuals perception that each investment is isolated from the others

Behavioural finance or how to adapt in time

This new approach of finance revolutionises both analysis methods and portfolio management. It may be impossible to foresee a price in the long run, but it is possible to adapt in time to the environment and benefit from financial trends generated by psychology.

How can we make an optimum use of behavioural finance analysis?

How can we distinguish negative trends from more favourable ones?

How can we reach a greater appreciation of risks and opportunities?

It is the challenge the Quanteviour model has taken up.