Hersh Shefrin - Beyond greed and fear: understanding behavioral finance and the psychology of investing

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Understanding Behavioral Finance and the Psychology of Investing

Hersh Shefrin

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Library of Congress Cataloging-in-Publication Data
Shefrin, Hersh, 1948
Beyond greed and fear: understanding behavioral finance and the psychology of investing /
Hersh Shefrin
p. cm.(Financial Management Association survey and synthesis series)
Originally published: Boston: Harvard Business School Press 2000.
ISBN 0-19-516121-1
1. InvestmentsPsychological aspects. 2. Stock exchangesPsychological aspects.
3. FinancePsychological aspects. I. Title. II. Series.
[HG4515.15. S53 2002]]
332.6019dc21 2002010047

For Arna

Behavioral finance is the study of how psychology affects finance. Psychology is the basis for human desires, goals, and motivations, and it is also the basis for a wide variety of human errors that stem from perceptual illusions, overconfidence, over-reliance on rules of thumb, and emotions. Errors and bias cut across the entire financial landscape, affecting individual investors, institutional investors, analysts, strategists, brokers, portfolio managers, options traders, currency traders, futures traders, plan sponsors, financial executives, and financial commentators in the media. This book is about recognizing the influence of psychology on oneself, on others, and on the financial environment at large.

I take some pride in the fact that Beyond Greed and Fear was the first comprehensive treatment of behavioral finance. However, the greatest satisfaction comes from witnessing the enormous growth that has occurred in the field since the book was first published in 1999.

As a field, behavioral finance is flourishing, not only in academia where financial issues are studied, but also in practice where behavioral concepts are coming to be routinely applied. One only need do a web-based search on behavioral finance to see how the field has virtually exploded.

Behavioral finance is now represented in almost every leading academic department of finance in the United States. Some universities, such as the University of Mannheim in Germany, have established institutes dedicated to the subject. The Social Science Research Network has a separate newsgroup devoted to behavioral and experimental finance. Behavioral papers are now routinely presented at every major academic finance meeting. Articles devoted to behavioral topics are winning Best Paper awards. Two notable instances are the Smith Breeden Prize and the William F. Sharpe Award. The Smith Breeden Prize was awarded to Kent Daniel, David Hirshleifer, and Avanidhar Subrahmanyam for the best paper published in the Journal of Finance during 1999. They wrote Investor Psychology and Security Market Under and Overreactions. The William F. Sharpe Award for Scholarship in Financial Research was awarded to Meir Statman and me for Behavioral Portfolio Theory, which appeared in the Journal of Financial and Quantitative Analysis in 2000.

The Review of Financial Studies and the Financial Analysts Journal have devoted entire issues to behavioral finance, and the Journal ofEmpirical Finance is planning a future issue, again dedicated to behavioral finance. The International Library of Critical Writings in Financial Economics is a compendium of edited collections in the various areas of finance. As a testament to its growing importance, a three-volume set on behavioral finance, which I was privileged to edit, appears in this collection, alongside more traditional areas such as corporate finance, futures markets, market efficiency, debt markets, options markets, and market microstructure.

Behavioral perspectives are routinely reported in major newspapers such as the Wall Street Journal. In January 2002, the New York Times profiled the work of Richard Thaler, one of behavioral finances leading figures. In June 2001, the Financial Times devoted an entire section to behavioral finance. In 2002, public televisions The Nightly Business Report devoted a whole program to behavioral finance. Well-known value manager and Forbes columnist David Dreman has organized the Institute of Psychology and Markets, along with a new journal, the Journal of Psychology and Financial Markets.

Many new papers and books are being written on behavioral topics. Shortly after Beyond Greed and Fear was published, two related behavioral books appeared, both by leading behaviorists. Irrational Exuberance by Robert Shiller is a highly acclaimed work, describing the psychological factors that produced a stock market bubble during the 1990s.