Archive for May 25th, 2007

Using Behaviour Finance to understand savings in India

May 25, 2007

I have been trying to get this database provided by Finance Ministry of India for quite sometime but the link was not working. Now it has been fixed and I am hooked. Basically, it has been derived out of a survey done amongst the individuals employed in the unorganised sector asking numerous questions on their saving and investment behaviour.

The methodology and the questionnaire have been provided as well. The database is huge (almost 34 MB) so people with bandwidth constraint may have a problem. But those that can, should download it for some pretty interesting analysis.

It shows that people prefer fixed income securities for their savings, have little awareness about Mutual Funds, shares and so on. Well, what got me the most interested was this question (abridged verion):

Suppose you have Rs 1000 with you which you want to invest. Here are the three choices given to you:

  1. After one year your Rs. 1000 could become Rs. 2000 or could also become Rs. 500
  2. After one year your Rs. 1000 could become Rs. 1200 or could also become Rs. 800
  3. After one year your Rs. 1000 would become Rs. 1050 and you do not loose anything

What do you think the choice would be? Before that let us rank these choices:

  1. Assuming 50:50 probability of the event happening, the expected value after year 1 is ( 0.5 * 2000 + 0.5 * 500 = Rs 1250)
  2. 0.5 * 1200 + 0.5 * 800 = Rs Rs 1000
  3. Rs 1050

Hence going by classical finance theory the choices in order are 1,3 and 2. But the survey revealed something different choices:                                                            


Choice 1 Choice 2 Choice 3
Urban   10.76% 14.40% 74.85%
Rural   9.85%  12.98%  77.17%
All India  10.31% 13.70%  75.99%

These results would definitely make a behavior finance follower smile and classical finance follower frown. Choice 3 wins hands on, despite Choice 1 offering higher expected value. Both at rural and urban the favorite was choice 3. People simply hate any losses on their money.

Well, the result is nothing new and has been explained by nobel laureate Kahnemann and his colleague Tversky (who missed out on the nobel as he had passed away before the nobel). The theory was  called Prospect theory and was developed as back as 1979. The basic idea is simple: given a position of profits humans become risk averse and when there is a position of losses humans turn risk-seeking.

Well, I wanted to point this out as there have been many research papers explaining this behaviour in US and other markets, but I haven’t come across something like this for Indian markets. Overall, the database has some very interesting points which I would try and cover later.

Assorted Links

May 25, 2007

1. You have to read this speech from India’s finance minister Chidambaram. It is given at a CII conference on Mumbai as a whatever International Centre. He simply pours his heart out. Sample this:

“The last time I spoke about Mumbai, and I said, with a very careful choice of words, that I would like Mumbai, the city of Mumbai to have a large degree of autonomy in governing itself because that is how large cities govern themselves. The next morning I read that someone was threatening to cut off my tongue. The point is not what powers Mumbai has, but what kind of governance structure Mumbai will have, in order to effectively provide the services, which Mr Entwistle mentioned. “

2. Law firms mostly have a partnership structure, here we have the first law firm which has listed itself on the exchange.  It is a great development for capital markets, after private equity firms (Blackstone) we have a law firm accessing capital markets. It is an Australian firm and is called Slater & Gordon.

3. A wow article from Austan Goolsbee(Univ of ChicagoProfessor) on why Mr Warren Buffert’s strategy of picking his successor by giving 3-4 top candidates USD 5 billion and picking the best performer after 2 years of fund management. Sample this:

“For all of Mr. Buffett’s reputation as the ultimate nonmutual fund, he may have just fallen into one of the biggest mutual fund traps of all — forgetting how incentives affect fund managers’ behavior.”

Further he adds:

“In a fund doing well but not stellar in the first three quarters of the year, the manager has a clear incentive to take big risks. If the risks pan out, the payoff in the last quarter can raise the fund’s return enough to get it into a top 10 list, say, and attract a huge number of new investors. If the risk doesn’t pay off, the return will be lower but the fees won’t be too much lower than they were before. The study showed that managers responded rather directly to these incentives. The managers heading toward the top of the ranking increased their risk-taking significantly in the last quarter of the year whereas those in the middle played it extra safe. “

4. The significance of Shanghai Stock exchange touching 4444. Read on

Thanks to Ajay Shah for 1, Finance Professor for 2 and Greg Mankiw for 3.

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