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Why The Most Important Idea In Behavioral Decision-Making Is A Fallacy
The author seems to have a different notion of risk aversion than I would, especially when he equates financial decisions with sports choices, or draws any conclusion about a $10 gain/loss. What I'd consider as risk aversion, he dismisses as rational behavior. Well, yeah -- that's why I'm averse to that risk.
The author is a professor of marketing, not a psychologist. He could be very knowledgeable on this subject, but this blog entry is not very convincing. I think it's very difficult to know what motivates people.
Conclusion: “In sum, our critical review of loss aversion highlights that, even in contemporary times, wrong ideas can persist for a long time despite contrary evidence, and therefore, that there is a need to critically assess accepted beliefs and to be wary of institutional consensus in science and otherwise. While loss aversion has frequently been cited to explain why people are biased toward the status quo, perhaps fittingly, the case of loss aversion illustrates the importance of challenging science’s status quo.”
Sounds like somebody trying to impress their college prof.
I don’t know. If everyone were more concerned about possible loss than possible gain, you’d think that ...
- Sports betting would cease
- Casinos would close / State lotteries would go bust
- Motorists would typically drive 10 mph under posted limits
- Manias and bubbles in assets (like stocks and real estate) would never exist
That post links to a column that in turn cites the paper that the Scientific American piece linked here is summarizing. How's that for circular references
That column argues that loss aversion is still real, though it suggests a refinement to the concept.
My question is: if investors do not weigh losses more heavily than gains (i.e. are averse to losses), then why do so many people here keep looking at Sortino ratios and maximum draw downs? Why don't we have maximum gain data as well?
That's not a joke. I'm as concerned when a fund I have performs way out of line with my expectations on the upside as when it underperforms.
I owned a legacy fund that had originally been an income oriented sector fund that evolved into a respectable broad based large cap value fund. I had been considering selling it for a variety of reasons. What finally made me pull the trigger was one year when it wound up as the top performing LCV fund (can't verify, but M* says it was in the top 1%).
The fund was so volatile that even with top quartile returns for the past 3, 5, and 10 years, it had a 1* rating. Yet the last straw for me was the upside risk.
So, why all these biased metrics? Junk statistics, or do investors really care more about their risk of loss then their risk of gain?
People doling out advice never have to invest their own money based on that advice. Because they earn their keep because of us. And we have to invest so we can fund them. And they get paid regardless of whether we gain or lose money. And always, ALWAYS it is never their fault, and always ours. If Investor loses money, it is always investors fault.
I've been saying a long time if $USD is going up international/emerging markets suffer. I call it common sense. Of course I will not win any nobel prize because like Ed Yardeni, I don't call it "stay home strategy".
Marketing? Absolutely. In today's times searching twice on Google implies "Re"search.
Now I'll wait for the blog posts to become a book. NOT.
My question is: if investors do not weigh losses more heavily than gains (i.e. are averse to losses), then why do so many people here keep looking at Sortino ratios and maximum draw downs? Why don't we have maximum gain data as well?
It might be (in studying potential downside) that people are seeking to rationalize the risks they take - in effect, to convince themselves that the risks are small compared to the gains they expect.
We don’t have maximum gain data. How could you? But after a 10-year bull market most risk-asset numbers look rosey. By contrast, after a bear market where 40-50% losses were experienced, the reverse might be the case. People might need convincing that “The sun will come out tomorrow.”
There’s a reason the play Annie is set in the Great Depression years. Here’s some well done clips from live stage. Gotta love it.
Interesting points made here. I don't want to paraphrase @msf (because he's perfectly clear in his writing), but the idea that "volatility" has become synonymous with a decline in securities is missing a dimension. Pundits frequently warn us about coming volatility, yet they don't seem to be talking about up as well as down. Volatile to me means unpredictable, especially when talking about an unstable individual. Same should be the case when talking about markets.
Comments
What I'd consider as risk aversion, he dismisses as rational behavior. Well, yeah -- that's why I'm averse to that risk.
The author is a professor of marketing, not a psychologist. He could be very knowledgeable on this subject, but this blog entry is not very convincing. I think it's very difficult to know what motivates people.
David
Sounds like somebody trying to impress their college prof.
I don’t know. If everyone were more concerned about possible loss than possible gain, you’d think that ...
- Sports betting would cease
- Casinos would close / State lotteries would go bust
- Motorists would typically drive 10 mph under posted limits
- Manias and bubbles in assets (like stocks and real estate) would never exist
https://mutualfundobserver.com/discuss/discussion/40777/is-loss-aversion-a-myth
That post links to a column that in turn cites the paper that the Scientific American piece linked here is summarizing. How's that for circular references
That column argues that loss aversion is still real, though it suggests a refinement to the concept.
My question is: if investors do not weigh losses more heavily than gains (i.e. are averse to losses), then why do so many people here keep looking at Sortino ratios and maximum draw downs? Why don't we have maximum gain data as well?
That's not a joke. I'm as concerned when a fund I have performs way out of line with my expectations on the upside as when it underperforms.
I owned a legacy fund that had originally been an income oriented sector fund that evolved into a respectable broad based large cap value fund. I had been considering selling it for a variety of reasons. What finally made me pull the trigger was one year when it wound up as the top performing LCV fund (can't verify, but M* says it was in the top 1%).
The fund was so volatile that even with top quartile returns for the past 3, 5, and 10 years, it had a 1* rating. Yet the last straw for me was the upside risk.
So, why all these biased metrics? Junk statistics, or do investors really care more about their risk of loss then their risk of gain?
I've been saying a long time if $USD is going up international/emerging markets suffer. I call it common sense. Of course I will not win any nobel prize because like Ed Yardeni, I don't call it "stay home strategy".
Marketing? Absolutely. In today's times searching twice on Google implies "Re"search.
Now I'll wait for the blog posts to become a book. NOT.
@msf - great question
It might be (in studying potential downside) that people are seeking to rationalize the risks they take - in effect, to convince themselves that the risks are small compared to the gains they expect.
We don’t have maximum gain data. How could you?
There’s a reason the play Annie is set in the Great Depression years. Here’s some well done clips from live stage. Gotta love it.
Would that be @Old_Joe you’re referencing?
Besides, what've I done bad, lately?