Archive for the ‘Behavior Eco/Fin’ Category

Mutual Fund SIPs are about psychology and not math (the idea is so similar to a chit fund…)

November 8, 2016

Dhirendra Kumar of Valueresearch usually has great pieces on personal finance and mutual fund matters. The best bit is he always sticks to basics and questions all the jazz which keep coming as hype only to disappear eventually.

In a recent piece, he questions all the noise around Systematic Investment Plans. There are lot of ads showing all the math around SIP:

There are now some six-seven types of SIP available from Indian mutual funds. You can have ‘value-based’ SIPs; SIPs with different periodicities, which claim better returns; SIPs that split monthly instalments into weekly ones; SIPs which claim different dates give better returns; and SIPs that vary your monthly investments according to even more complex formulae.

That’s a lot of choice, and consumer choice is always supposed to be good, right? Well, not quite. I’ll put it bluntly. Having lots of choices in SIPs is an unequivocally bad thing. These choices misguide people as to what the real purpose of SIPs is and how they can succeed at SIP investing.

Worse, they promote the idea that the way to get better returns lies in some newly discovered trick or feature that is available in some SIPs and not in others. This is a bogus idea. The value of an SIP lies in its simplicity.

…..

An SIP is all about investing a fixed sum regularly in an equity fund, regardless of market conditions. Over the long term, you end up buying more units when the markets are down and fewer when the markets are up. Thus, your average purchase price is much likelier to be lower than what it would have been otherwise. Therefore, when the time comes to redeem your investments, they are very likely to be worth more than what they would have been. That’s all there is. There are no guarantees, and there are certainly no fixed formulae of expected returns. ….

However, there is a bigger reason to invest through an SIP. The real value of an SIP is not in maths but in psychology. SIPs are the simplest way of investing regularly and getting good returns from equity, without having to worry about when to invest and when not to invest and thus often missing out on the best opportunities. When the markets turn discouraging, the general instinct of many investors is to stop investing, either because they are scared or because they are trying to catch the bottom. However, SIP investors – not all but most – tend to continue their SIPs. Soon, when the markets go up, this teaches them the value of not stopping their SIPs in bad markets. Thus begins a virtuous cycle, creating a larger new generation of investors who understand the value of regular investing.

This is so true. It is more about psychology than anything else. Much of finance is around psychology as it moves based on so many expectations driven by behavior of so many people. Math is just an effort to add some sanity to the picture but makes it endlessly complicated.

I was thinking about something else. It is interesting how things in finance are interconnected and keep going in circles. What is the history of these SIPs? How did they start and where did the idea come from?

I ask this as the idea for a SIP is hardly new. The chit funds which are a thousand year old financial mechanism, the idea was same. Contribute small amounts regularly just to develop that saving habit. Just that in a MF the proceeds are invested in some securities and one is given units showing the ownership of the stocks. Overtime, the amount invested grows which one can use later for consumption or other things.

In chit funds, one instead bid for the pool to use it for consumption purposes. The securities markets had not developed back then and people needed money higher than their savings. So, this system was devised. It also avoided problem of collateral.

Just like in a MF the fund manager matters, similarly in a chit fund the foreman mattered (there was no case of women running the funds despite their origination in Malabar which had a matrlineal system). The foreman is responsible to collect the funds periodically and investors have to ensure that he does not run away.

So there are these similarities and there are these differences as well. But the idea of using human psychology and save regularly  is the crux behind both. SIP may look and sound modern but similar thoughts started much earlier.

There are a few of these core ideas which keep coming and going back and given new names. One could impart such ideas while teaching finance than the usual math way.

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What can regulators learn from behavioural finance ?

October 25, 2016

It is exciting to note that financial services industry is employing behavioral economics people. Sarah Newcomb a PhD in behavioral economics is working with Morningstar as a behavioral economist.

In her recent interview with Business Line she offers a basic primer on the field. One of the qs was What can regulators learn from BF?

For those creating policy, the important thing is to make sure that the incentives of people selling financial products must align with the incentives of people buying financial products. In the US, for instance, we are seeing regulations tighten to ensure that advisors sell products that are in the client’s best interest. If a client has a portfolio allocation that is fine to begin with, and there is a new product that the advisor is selling him, and if the only advantage of the new product is that he is paid to sell it, then you’re adding risk and transaction costs and higher fees to a portfolio that is already fine.

What about financial advisors?

One of the biggest barriers we found in behavioural science that keeps us from making good financial decisions is that we discount the future. When something is closer and immediate, we see those costs and benefits as disproportionately large as opposed to our mental picture of the costs or benefits of something in 10 years. So, we repeatedly, in academic studies, take small immediate rewards over large rewards later.

One thing that shows promise is using psychological distance to our advantage. We’ve seen that when people have a closer relationship with your future self, you make better financial decisions. One of the things you can do is age-progress your face, it puts clarity and detail in your own picture of you. It’s like a little brain hack that makes your future more real and the consequence of your saving or not saving feel more real. Another thing that financial advisors can do for clients is to get them to put a lot more detail into the mental picture of their lives in the future.

Hmm. Interesting bit..

Using Behavioral insights in monetary policy…

September 26, 2016

Mark Calabria of Cato has a nice short paper reviewing the literature on the topic.

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Indian Government to finally set up a Nudge unit!

September 7, 2016

Niti Aayog has finally bitten the bullet and decided to set up a Nudge unit. This is obviously going to be on lines of UK’s Behavioral Insights Unit.

It will be interesting to see when this will start and its work..

How econs first developed discipline of marketing, then dumped it and now need to revisit it..

September 1, 2016

Philip Kotler is one name most management students are atleast aware of.

In this piece he talks about economists topsy turvy relationship with field of marketing:
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Designing a behaviourally informed banking market

August 17, 2016

BIT  blog has a post on the topic:

Last week the Competition and Markets Authority (CMA) published the final report of their retail banking market investigation. The CMA has identified that currently, only a tiny proportion of customers switch to a different bank in any year; despite the fact that many of them could save about £90 a year by switching. A quarter of people in the UK use an unauthorised overdraft each year, suggesting they do not have the best account for them: this earns the banks £1.2 billion a year from unauthorised overdraft charges.

The report proposed three foundation measures as the basis for their package of remedies. All three foundation measures have strong behavioural aspects:

  1. Requiring banks to implement Open Banking to help consumers share their data securely with other banks and third parties. This will help make it easier for consumers to shop around and compare banking products (making it easy).
  2. Requiring banks to prominently display a number of core indicators of service quality, including whether a personal customer or small business is willing to recommend their bank to friends, family and colleagues (making it attractive).
  3. Introducing routine and occasional prompts for personal and business customers to encourage them to consider their current banking arrangements and shop around for alternative banking services (making it timely).

Those of you who have read our recent report on applying behavioural insights to regulated markets will recognise that these remedies strongly echo the principles set down in that paper: we will now set out their behavioural underpinning in a bit more detail.

The post goes on to explain all the three making it easy. making it attractive and making it timely..

How to make GST a success by nudging people to go for pucca bills…

August 16, 2016

All kinds of ideas are emerging on how to make GST a success. Right from prescribing the right revenue neutral rate (why use such a complicated term) to state participation, all is being written and discussed.

Dhirendra Kumar of Value Research gets to the basics and looks at this issue of people preferring kaccha bills (fake) over pucca bills (authentic) to avoid taxes. After all, much of GST is around this idea of paying only value added tax across goods and services. This will require proper billing across the cycle for the tax to work.

How will the government ensure people will suddenly switch to a proper billing system and pay taxes? He points to this interesting solution – Taiwan Uniform Invoice Lottery:

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Using prospect theory to figure today’s monetary policy and its impact on markets..

August 12, 2016

Prof Jayant Varma of IIM Ahmedabad has a nice post which gets to the crux of the negative interest rate issue.

He says as bonds have negative rates, the concept of yield/coupon etc is lost. So, investors are looking at bonds in terms of prices alone just like stocks. Whereas, investors are looking at stocks as bonds as they give dividends. So bonds are the new equities and equities are the new bonds.

This is like the prospect theory applying in monetary policy as risk averse bond investors are seeking risks in wake of losses:

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A short primer on behavioral economics..

August 11, 2016

Eyal Zamir of Hebrew University of Jerusalem (Faculty of Law) has a short piece on behavioral economics. Paper is titled as law and economics but much is on economics. After all economics is seen as much cooler than anything else.

The author discusses various heuristics and how that distorts the rational thinking. He also points to the criticism on the field.

A host of critiques have been leveled against JDM research, as well as its implications for economic analysis in general, and for economic analysis of law in particular. One critique is that the JDM research agenda has over-emphasized the instances in which heuristics lead people astray, when in fact heuristics are an excellent, fast, and frugal way of decision-making in most cases (Gigerenzer, Todd et al. 1999). While this contention may well be true, its implications appear to be limited—akin to asking whether the glass is half empty or half full. Some commentators, especially those concerned about the possible paternalistic implications of JDM studies, have questioned the external validity of JDM laboratory findings, arguing that they may disappear with monetary incentives, or that the market is expected to drive out bad judgment (see, e.g., Mitchell 2002). However, these claims run counter to the findings of thousands of empirical studies. These include studies attesting to the prevalence of cognitive biases in real-life behavior and studies demonstrating that incentives often do not eliminate biases, and sometimes even exacerbate them. Moreover, while market competition may possibly drive out firms whose managers fall prey to cognitive 9 biases, competition concomitantly strengthens the incentive for suppliers to exploit consumers’ biases.

Finally, an important critique commonly leveled against behavioral studies is that they produce a long list of heuristics and biases, rather than a unifying, simple model of judgment and decision-making of the sort provided by RCT. In response, considerable progress has been made in recent years in systematization and theorization of JDM. However, ultimately one must concede that there is an inevitable tradeoff between descriptive validity and simplicity. As Kahneman has put it, “life is more complex for behavioral economists than for true believers in human rationality” (Kahneman 2011, p. 412). Disregarding this complexity and pretending that people are rational maximizers is not a compelling strategy for legal theoreticians and policymakers, since the law has a powerful impact on the real lives of real people.

Behavioral thinking is just one of the ways to provide alternative thinking to the rational school. Neither it is “the framework” nor the researchers should push it on those lines.

It has been known that  people are not rational and assuming the same is oversimplification. But due to lack of ideas on the same, the assumption continued. This was challenged by psychologists like Kahneman and Tversky who provided with frameworks to think through how behavior influences economic decisions.

The problem is rational school remains the dominant way of teaching in economics. Beh eco remains in the fringes and at best offered as an elective in few places. So it does not help students appreciate an alternative framework. This is where bulk of the trouble has always been. Let students figure which framework suits them rather than just fight amidst each other for superiority.

There is space for everyone in the game..

Debate between efficient finance school and behavioral finance school…

August 9, 2016

The two leaders of both the schools – Profs. Eugene Fama and Richard Thaler – debate over financial markets (HT MR blog) .

Nice bit..

Using behavioral insights to figure UK Police’s 101 phone calls

July 29, 2016

Simon Ruda and Alex Tupper of UK’s Behavioral Insights Team have a piece on the analysis.

UK introduced a phone number 101 to address all police related issues. This led to lot of calls which had nothing to do with police. Could BIT help find patterns for the Police to seperate calls to attend vs not t attend?

When conducting the analysis, as ‘inappropriate calls’ weren’t coded in the data, BIT assumed that any phone calls which were resolved in under 30 seconds were likely to be inappropriate for the Police (i.e. where the caller was quickly told their enquiry wasn’t something the police deal with).

One of the most intriguing findings was that the proportion of inappropriate calls received is dramatically reduced if the call waited at least five seconds before being answered. It could be that just five seconds of ringing time is enough to enable the caller to reflect on the purpose of their call and its appropriateness for the police.

As the graph below shows, around four in every ten calls answered within 1 second were inappropriate, whereas only one in ten of those that wait at least 6 seconds are. The possible conclusion from this analysis is that a ring time of just 6 seconds could help cut down inappropriate calls, enabling those in real need of support to be prioritised and more rapidly assisted by the police.

101

Hmmm..Interesting stuff..

 

You sound cooler if called a behavioral economist instead of a psychologist…

July 15, 2016

Adam M. Grant of Wharton School has a piece highlighting this dilemma. He is a psychologist but is often introduced as a behavioral economist on order to sound cooler and be heard.

He says this change in events is ironical as most contributions to so called beh eco comes from psychologists:

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Revisiting the tax compliance problem using prospect theory

July 12, 2016

R. Kavita Rao and Suranjali Tandon of NIPFP have this interesting paper.

Should one file or not file a tax? What are the behavioral implications?

The paper presents a model for tax compliance based on prospect theory wherein an individual makes the decision whether to file, and declare a certain amount of income, or to not file based on a set of policy parameters as well as his/her preferences. The paper poses the question- at what incomes would individuals choose to file a return and answers the same using a model based on prospect theory. Further, simulations are presented to illustrate the impact of changes in tax rates, penalty and audit probability on the individual’s preference to file. The results from the simulation show that for different values of policy parameters there exists crossover income at which individuals would choose to file a return. Given all else, at the exemption threshold of 0.1 million, individuals would choose to file a return at incomes greater than or equal to 0.6 million.

Hmmm…

One would like to also read on an experiment verifying the model..

How behavioral economics explains voting for Brexit..

July 8, 2016

Chris Dillow, uses ideas from behavioral economics to explain why people voted for Brexit despite it harming their economic opportunities.

This Brexit vote is actually nothing new. People have voted in the past which doesn’t explain

We economists – especially those of us who are on the left – have got a problem: voters don’t agree with us.

Events a few days ago demonstrated this. But it is in fact a longstanding issue. For years, and around the world, voters have had attitudes opposed to ours. They have been more hostile to immigrants and benefit claimants and more supportive of austerity and inequality than we would like. (This isn’t just an issue for the left: voters also have anti-free market attitudes.)

Why is this? I want to suggest that it is because Marxists were right all along. It’s because capitalism generates an ideology which opposes sensible radical reform. The idea of false consciousness should be taken a lot more seriously.

I came to this view via an apparently circuitous route. In my brief and ignominious career in finance, I learned about behavioural finance. This field, inspire by Daniel Kahneman’s work on cognitive biases, is the idea that people make small but systematic errors of judgment when managing their money. But this raises a question. If people are subject to cognitive biases when they have big incentives to be right – when they are investing their own money – might the same be true in politics, where their incentives are less sharp?

Some experimental research suggests the answer is: yes.

So what explains?

I suspect three mechanisms helped here. One was wishful thinking.

Another is prospect theory. This tells us that people who feel they’ve lost want to gamble to break even. This is why they back longshots on the last race of the day or why they hold onto badly performing stocks. The thing motivated many Leavers. People who had lost out from globalization, or felt discomfited by immigration, voted Leave because they felt they had little to lose from doing so.

The third mechanism has been discovered recently by David Leiser and Zeev Kril. They show that laypeople’s thinking about economics is dominated by what they call the “good begets good” heuristic. People believe that good things have good effects.

This, I suspect, explains a lot. People think controlling the public finances, or controlling immigration, are good things, so they must have good effects. I shouldn’t need to tell you that it ain’t so. In this context, the slogan “Vote Leave, Take Control” was an act of genius. It appealed to the “good begets good heuristic as well as to the fact that people facing uncertainty and feeling distrustful of elites want more control for themselves. (Perhaps this is fuelled by yet another cognitive bias – overconfidence about the benefits of such control)

It is interesting how prospect theory helps us understand so many things around the world. Its usage is limited but is catching up…

Railways nudge to sensitise people towards subsidy on train tickets

June 24, 2016

Interesting bit from Indian railways. It will now be printing the subsidy on the railway tickets:

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Applying behavioural economics to public policy (Is Indian polity listening?)

June 6, 2016

The post is on Canadian public policy but I guess it applies to most countries. There is an interesting video on nudging people to use stairs instead of elevators. Though the nudge is slightly noisy. Do see it.

There are numerous ways in which nudges can work:

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A parable about incentives backfiring…

June 3, 2016

Pick up a basic economics textbook and it most likely will start with incentives. All that seems to matter in economics is incentives. If you get the incentiving right, people are likely to respond in the desired way. Any behavior away from the norm defined by economists is blamed on incentives.

However, life is hardly that simple. People react differently even if incentives are supposedly right. This is where behavioral economics also comes in. This post by Samuel Bowles (HT: INET Blog) also points to a story with people responding negatively to certain actions:

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Should railways offer opt-in or opt-out for meals in privileged trains?

May 30, 2016

As a railways and beh econ buff it is exciting to read this bit. It is even more exciting to see something come into action which this blog argued nearly three years ago.

One always wonders the logic behind food being compulsory in India’s privileged trains like Rajdhani and Shatabdi. Most of the time food is bland and hopeless. If one takes a Rajdhani on a longer route rest be assured food is going to be the same across meals. As one has paid for it either one takes it or just wastes it. There are quite a few cases who carry their own food despite paying for it in tickets.

In 2013, this blog argued to change this default choice:

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How taxmen are tracking your Facebook pictures to ensure proper filing of taxes…

May 23, 2016

Never underestimate the government especially when it comes to collecting more and more taxes. One may be posting his/her pics on EB to draw several likes and neighbor’s envy but is now also drawing attention from tax authorities.

Next time you are hiding your taxes saying low business income etc for the year, pop will come a picture from your Facebook showing a foreign holiday recently. The question the tax person will ask is if incomes are indeed low how did this holiday come about?

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Endowment bias due to modern capitalism?

May 10, 2016

David Berreby has this fascinating post summarising this paper on what drives endowment bias.  What is endowment bias? There is a cup to be traded. AS a buyer you are willing to pay Re 1 for it but as a seller you want Rs 5 for the same cup. If one believes in markets, then price of the cup should be same whether you are a buyer or seller. This is called endowment bias where you value something more just because you owe it. This is one the classic anomalies pointed by behavioral economics.

The question is what drives this bias? In this experiment on hunter gatherers they start to show endowment bias as exposed to markets:

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