Hi, Shalu
Maybe you will find what you are looking for in:
http://equity-premium.behaviouralfinance.net/
Peter

--- In Behavioral-Finance@yahoogroups.com, "Shalu Kalra"
<shalukalra@...> wrote:
>
> Hi,
>
> Does any one knows about any paper that talks about that investor
participation in stock market is dependent on their perception about
risk premium.
>
> It will be really helpful.
>
>
> Thanks,
>
> Shalu
>
> -----Original Message-----
> From: Behavioral-Finance@yahoogroups.com [mailto:Behavioral-
Finance@yahoogroups.com]On Behalf Of pgreenfinch
> Sent: Wednesday, November 22, 2006 11:49 PM
> To: Behavioral-Finance@yahoogroups.com
> Subject: [Behavioral-Finance] Article of the month: Dare to be dull
>
>
>
> This month, the article we will focus on doesn't come
> from the glossary, but is a Thanksgiving present from
> Colorado Springs by our member Allan Roth the founder
> of Wealth Logic. He wrote for us a contribution titled
> with his motto "Dare to be dull".
>
> In that article, Allan talks about the "Las Vegas effect"
> due to mental accounting. He demonstrates mathematically,
> to the typical investor who saves his hard-earned money
> aiming at future financial independance, the danger of
> adjusting one's portfolio continuously. Human instinct
> would entice investors to do such active reshuffling,
> but Allan tells them to resist that emotional temptation
> to overtrade. If I might sum it up in my own words, his
> advice is: "better be dull than sorry".
>
> As there are good illustrations in his article I will not
> reproduce the text here, it is better that you click
> directly at Allan's contribution at :
> http://perso. <http://perso.orange.fr/pgreenfinch/daredull/dare%
20to%20be%20dull.htm> orange.fr/pgreenfinch/daredull/dare%20to%20be%
20dull.htm
>
> Thannking Allan for his contribution, which I'm sure will
> bring fruitful discussions in our group.
>
> Peter
>

Also, Shalu, for other approaches than the one I mentionned
below on "equity premium / risk premium", maybe you should
try to look also at "risk perception", "base rate fallacy",
"myopic loss aversion".

Behavioral finance is quite generous about semantics. It is
a sure way to riches... at least to a rich vocabulary ;-))

Peter

--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
> Hi, Shalu
> Maybe you will find what you are looking for in:
> http://equity-premium.behaviouralfinance.net/
> Peter
>
> --- In Behavioral-Finance@yahoogroups.com, "Shalu Kalra"
> <shalukalra@> wrote:
> >
> > Hi,
> >
> > Does any one knows about any paper that talks about that
investor
> participation in stock market is dependent on their perception
about
> risk premium.
> >
> > It will be really helpful.
> >
> >
> > Thanks,
> >
> > Shalu
> >
> > -----Original Message-----
> > From: Behavioral-Finance@yahoogroups.com [mailto:Behavioral-
> Finance@yahoogroups.com]On Behalf Of pgreenfinch
> > Sent: Wednesday, November 22, 2006 11:49 PM
> > To: Behavioral-Finance@yahoogroups.com
> > Subject: [Behavioral-Finance] Article of the month: Dare to be
dull
> >
> >
> >
> > This month, the article we will focus on doesn't come
> > from the glossary, but is a Thanksgiving present from
> > Colorado Springs by our member Allan Roth the founder
> > of Wealth Logic. He wrote for us a contribution titled
> > with his motto "Dare to be dull".
> >
> > In that article, Allan talks about the "Las Vegas effect"
> > due to mental accounting. He demonstrates mathematically,
> > to the typical investor who saves his hard-earned money
> > aiming at future financial independance, the danger of
> > adjusting one's portfolio continuously. Human instinct
> > would entice investors to do such active reshuffling,
> > but Allan tells them to resist that emotional temptation
> > to overtrade. If I might sum it up in my own words, his
> > advice is: "better be dull than sorry".
> >
> > As there are good illustrations in his article I will not
> > reproduce the text here, it is better that you click
> > directly at Allan's contribution at :
> > http://perso. <http://perso.orange.fr/pgreenfinch/daredull/dare%
> 20to%20be%20dull.htm> orange.fr/pgreenfinch/daredull/dare%20to%
20be%
> 20dull.htm
> >
> > Thannking Allan for his contribution, which I'm sure will
> > bring fruitful discussions in our group.
> >
> > Peter
> >
>

-----Original Message-----
From: Behavioral-Finance@yahoogroups.com [mailto:Behavioral-Finance@yahoogroups.com]On Behalf Of pgreenfinch
Sent: Sunday, December 03, 2006 2:39 PM
To: Behavioral-Finance@yahoogroups.com
Subject: [Behavioral-Finance] Re: Investor Participation and perception about risk premium

Also, Shalu, for other approaches than the one I mentionned
below on "equity premium / risk premium", maybe you should
try to look also at "risk perception", "base rate fallacy",
"myopic loss aversion".

Behavioral finance is quite generous about semantics. It is
a sure way to riches... at least to a rich vocabulary ;-))

Peter

--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
> Hi, Shalu
> Maybe you will find what you are looking for in:
> http://equity-premium.behaviouralfinance.net/
> Peter
>
> --- In Behavioral-Finance@yahoogroups.com, "Shalu Kalra"
> <shalukalra@> wrote:
> >
> > Hi,
> >
> > Does any one knows about any paper that talks about that
investor
> participation in stock market is dependent on their perception
about
> risk premium.
> >
> > It will be really helpful.
> >
> >
> > Thanks,
> >
> > Shalu
> >
> > -----Original Message-----
> > From: Behavioral-Finance@yahoogroups.com [mailto:Behavioral-
> Finance@yahoogroups.com]On Behalf Of pgreenfinch
> > Sent: Wednesday, November 22, 2006 11:49 PM
> > To: Behavioral-Finance@yahoogroups.com
> > Subject: [Behavioral-Finance] Article of the month: Dare to be
dull
> >
> >
> >
> > This month, the article we will focus on doesn't come
> > from the glossary, but is a Thanksgiving present from
> > Colorado Springs by our member Allan Roth the founder
> > of Wealth Logic. He wrote for us a contribution titled
> > with his motto "Dare to be dull".
> >
> > In that article, Allan talks about the "Las Vegas effect"
> > due to mental accounting. He demonstrates mathematically,
> > to the typical investor who saves his hard-earned money
> > aiming at future financial independance, the danger of
> > adjusting one's portfolio continuously. Human instinct
> > would entice investors to do such active reshuffling,
> > but Allan tells them to resist that emotional temptation
> > to overtrade. If I might sum it up in my own words, his
> > advice is: "better be dull than sorry".
> >
> > As there are good illustrations in his article I will not
> > reproduce the text here, it is better that you click
> > directly at Allan's contribution at :
> > http://perso. <http://perso.orange.fr/pgreenfinch/daredull/dare%
> 20to%20be%20dull.htm> orange.fr/pgreenfinch/daredull/dare%20to%
20be%
> 20dull.htm
> >
> > Thannking Allan for his contribution, which I'm sure will
> > bring fruitful discussions in our group.
> >
> > Peter
> >
>

Most professionals and academicians agree that the Efficient Market
Hypothesis and rational participants do not reflect the real markets,
but no one has come up with a good alternative fix.  The website,
www.thencet.com , seems to provide the solution.  Take a look and let
me know your thoughts?

=> Note from the moderator:
Big job, "Finance guy 2007", for sure, but very theoretical.
I understand that maximizing satisfaction, as seems to be
the key concept here, is important, but any practical
example with real numbers?
Peter

--- In Behavioral-Finance@yahoogroups.com, "finance_guy_2007"
<finance_guy_2007@...> wrote:
>
> Most professionals and academicians agree that the Efficient Market
> Hypothesis and rational participants do not reflect the real
markets,
> but no one has come up with a good alternative fix.  The website,
> www.thencet.com , seems to provide the solution.  Take a look and
let
> me know your thoughts?
>
> => Note from the moderator:
> Big job, "Finance guy 2007", for sure, but very theoretical.
> I understand that maximizing satisfaction, as seems to be
> the key concept here, is important, but any practical
> example with real numbers?
> Peter
>

For examples, I'm creating a graphical representation to contrast the
differences between how prices are set for EMH participants, BF
participants, and the NCET's quasi-rational participants.  Once I get
that done, readers will more easily visualize the practical
implications of the NCET to "real" price processes.  This might save
me from providing a fully designed mathematical example (that could
become very complex).  I'm trying to avoid a numerical representation
because there are an infinite number of possible models (every market
is different, currencies have distinctly different price processes
than 30 year bonds).  If the generalized NCET theory is accepted, the
financial engineers and technical economists can take it to the next
level.

Hi, dear members and visitors!

I'm glad to send you our group's 79th month newsletter,
hope you find a good place for it on your christmas tree ;-)

To follow a discussion we had during that month, and also to
take into account what a new member just proposed, something
striking is that, although BF/BE gave a lot of insights in
investor biases and in market anomalies, there is a scarcity of
behavioral market modeling, for asset valuation among others, to
complement or take the place of standard theories.
Maybe this is because the task is daunting as the topic is quite
complex. Maybe also because it is not easy to apply maths to
"soft" things such as human and social goals and attitudes.
But that doesn't seem to me a satisfying answer. Even human
tastes lead to cooking recipes where the ingredients are
carefully weighed, mixed and put in the oven with precise
parameters of time and temperature.
Of course, "quants" try to apply detection tools to exploit any
anomaly, but that doesn't seem to lead to general models and
paradigms.
Any information about secret - or not so secret - models ?
Or any thoughts about their scarcity ?

1) Monthly activity

Our membership (subscribers / unsubscribers balance) grew
by about 15 with 1640 unbouncing members
We had 40 messages, and the total is now ca 7715.

Welcome to new members. And thanks to all contributors!

Our sister group, Finance-Academy grew a little too, with
ca 325 members now
http://groups.yahoo.com/group/Finance-Academy

2) Reminder : A poll is going on at
http://finance.groups.yahoo.com/group/Behavioral-Finance/polls
about what motivates the group's members in their interest
to BF. Thanks to give your "vote".

3) Our free BF resources at your fingertips 24/7:

* Your permanently updated and improved BF glossary
500+ definitions, many of them as detailed articles.
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.a.htm
    => every page in the glossary gives a link to
       a "quality" poll. Give your opinion, every
       comment helps!

* Martin Sewell's academic treasure chest in BF topics,
that site is a must for students and researchers:
http://www.behaviouralfinance.net/

* Your behavioral stockpricer (well, talking about BF models...):
http://perso.orange.fr/pgreenfinch/pricer.htm

* Our group charter
http://finance.groups.yahoo.com/group/Behavioral-Finance/files/
(click BF Group charter.doc)
also available at:
http://perso.orange.fr/pgreenfinch/befigrouppolicy.htm

** Remember, folks, that ou need a *yahoo ID/profile* to access
all Yahoo group's resources (polls, links and files),
To get it, click "account info" (in the group's homepage or your
"my groups" page) and fill in the info you deem appropriate

Wishing for a fireworks of quality info and debates in this
new month, so as to finish the year in style ;-)

Peter

Hi!

Every month, I submit an article from the BF glossary,
for information, to start a debate on the topic and to get
your observations.

This month I chose a classic: "Framing"
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.framing.htm

** START **

Framing is a biased way with which an issue, or an information,
is worded, described, perceived.
The formulation orientates the perception of the issue and the
direction of thoughts about it. It can change its analysis and
interpretations, lead to wrong ideas about it, and thus thwart
the conclusions and decisions (for example investment decisions).

How framing is done

To "frame" an issue is
* to narrow its definition or its presentation, by selecting
only one aspect,
* or to give a biased presentation of formulation, which
diverts the attention towards a specific interpretation

Not only the facts presented or selected, but also, the
vocabulary that is used can play an important part in framing
(neuro-linguistic). Other elements than words can also change
the picture. For example, everybody knows the effect of how
the wares are presented in shop windows, or of the way people
dress.

Examples of framing

*  3 dollars a day seems less costly than 1095 dollars a year.
*  Saying "there is 50% chance of success" instead of "50%
chance to fail" could change a decision (the famous half-full
or half-empty glass).
*  Some framing are due to pure reasoning errors, logical
fallacies, confusions, false information or false knowledge.

Then, the concepts or facts presented are mixed up or
misunderstood. An economic / financial example is confusing
nominal return rates with inflation-adjusted return rates
(money illusion)

Origins of framing

Framing can have two distinct origins, as it can be a personal
cognitive bias or be an outside misinformation :

* An internal / personal framing is done by the decider itself,
it can be
- either occasional (lack of attention, tunnel vision, but
also emotional situations blocking the analytical mind),
- or a result of the person's habit to look at information from
a single narrow angle
=> Here two sub-possibilities : either the person has a personal
cognitive or emotional bias, or the habit is common to a whole
group or population, as a result of social learning. In the
last case there is a joint phenomenon of internal and external
framing as seen below.

* An external framing: is the way the information is given by
the media, an adviser, the social group, etc. to the decider,

External framing can be 
- either done involuntarily, sometimes because of pure
incompetence from the author,
- or launched voluntarily by the initiator(s) (manipulation,
deception, neuro-linguistic).
=> Some hypes or demonizations are made just by using a word
for another, rewording a negative concept into a positive way,
or vice-versa (newspeak)

Most people are "frame dependent". They limit their approach to
one angle (tunnel vision). They select only one way (usually
the one that is immediately apparent or that fits their
one-sided beliefs) of defining questions they ask themselves,
or of building their decisions (see limited heuristics,
rationalizing).
This narrow definition of the question, or the limited scope of
their research; is conditioning their answer to it.

The risks of framing

In many life circumstances (look at the political debates before
an election to find a flurry of examples of misleading
presentations;-)), this narrow approach can be a source of wrong
decisions. In money management and in economic behavior, the
risk to follow unconsciously some red herring is very strong too.

Specific cases

* "Narrow framing" means people overlook the longer view and
focus their perception on the immediate future (short term bias). 
This is one of the reasons why putting money in pension schemes
is usually mandatory, as most people would not spare enough
voluntarily for their old days.
* It is advised to use a "wealth frame" for investing decisions.
This means to take into account all your present and expected
wealth (assets, debts, expected charge and revenues) so as not
to focus on a too narrow aspect.

** END **

What are your thoughts and info on the topic ?
Also, can the article be improved ?
Thanks for your interest.

Peter

Never heard of "range estimate aversion"?
Don't worry, I just coined the phrase, after hearing that
next year GDP will grow 2.4%, that the candidate XXX at
next year presidential election is given 33% votes in
the first round by a pollster, and that the nest quarterly
earnings per share expected for YYY is 53 cents

Thus I defined a decider's "range estimate aversion" as
a kind of framing. The fact that economic, financial,
managerial, political deciders, and also individual investors,

* Either determine a precise number (for GDP growth, sales,
stock price...) instead of a range of values that would allow
to see the various possibilities and risks among which to
build a strategy. They tend to focus on what they expect
will happen or not, and forget to imagine other possibilities.

* Or expect from experts and analysts to be given such a
precise number instead of a choice of scenarios

To reduce an estimate to one number can be classified as
a type of framing that gives the deciders an illusion of
certainty and water down their appreciation of risk.
Also, if things turn bad, it allows them to attribute
the responsibility on the expert, forgetting that the role
of the decider is to make choice, not obey to experts.

Now, what do you think and did some member heard about
some studies that would corroborate my home made concept?

Btw, wishing you a lot of home made cookies at the approach
of christmas, new year or other solstice festivities, sending
you my full range of season's greeting ;-)

Peter

I think that most single-point estimation is demand driven, that the
people making the estimate believe or know for fact that the people
seeing the estimate want a single number.

That's not framing as such, maybe related to anchoring?  Most people
who express a preference for a single-point estimate probably are
confused about precise and accurate - which are quite different
things.

Perhaps some of them are simply naive.  And perhaps as your post
suggests, many people have a phobic aversion to uncertainty and
grasp for the single number.

A reasonable preference for a single number would be if you expected
it to be an unbiased estimate and a range projection would be too
much effort to process and/or the result is not of benefit to use.

And of course, depending on what you are doing, a range estimate may
be worthless if it is so wide that the future outcome must 'fall
in'.

Jan


--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
> Never heard of "range estimate aversion"?
> Don't worry, I just coined the phrase, after hearing that
> next year GDP will grow 2.4%, that the candidate XXX at
> next year presidential election is given 33% votes in
> the first round by a pollster, and that the nest quarterly
> earnings per share expected for YYY is 53 cents
>
> Thus I defined a decider's "range estimate aversion" as
> a kind of framing. The fact that economic, financial,
> managerial, political deciders, and also individual investors,
>
> * Either determine a precise number (for GDP growth, sales,
> stock price...) instead of a range of values that would allow
> to see the various possibilities and risks among which to
> build a strategy. They tend to focus on what they expect
> will happen or not, and forget to imagine other possibilities.
>
> * Or expect from experts and analysts to be given such a
> precise number instead of a choice of scenarios
>
> To reduce an estimate to one number can be classified as
> a type of framing that gives the deciders an illusion of
> certainty and water down their appreciation of risk.
> Also, if things turn bad, it allows them to attribute
> the responsibility on the expert, forgetting that the role
> of the decider is to make choice, not obey to experts.
>
> Now, what do you think and did some member heard about
> some studies that would corroborate my home made concept?
>
> Btw, wishing you a lot of home made cookies at the approach
> of christmas, new year or other solstice festivities, sending
> you my full range of season's greeting ;-)
>
> Peter
>

My 1st observation is really a question; is a frame in the
Kahneman - Tversky meaning the same thing as a frame in the sense of
agenda setting and propaganda by politicos and spin doctors?

Jan

--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
> Hi!
>
> Every month, I submit an article from the BF glossary,
> for information, to start a debate on the topic and to get
> your observations.
>
> This month I chose a classic: "Framing"
> http://perso.orange.fr/pgreenfinch/bfglo/bfglo.framing.htm
>
> ** START **
>
> Framing is a biased way with which an issue, or an information,
> is worded, described, perceived.
> The formulation orientates the perception of the issue and the
> direction of thoughts about it. It can change its analysis and
> interpretations, lead to wrong ideas about it, and thus thwart
> the conclusions and decisions (for example investment decisions).
>
> How framing is done
>
> To "frame" an issue is
> * to narrow its definition or its presentation, by selecting
> only one aspect,
> * or to give a biased presentation of formulation, which
> diverts the attention towards a specific interpretation
>
> Not only the facts presented or selected, but also, the
> vocabulary that is used can play an important part in framing
> (neuro-linguistic). Other elements than words can also change
> the picture. For example, everybody knows the effect of how
> the wares are presented in shop windows, or of the way people
> dress.
>
> Examples of framing
>
> *  3 dollars a day seems less costly than 1095 dollars a year.
> *  Saying "there is 50% chance of success" instead of "50%
> chance to fail" could change a decision (the famous half-full
> or half-empty glass).
> *  Some framing are due to pure reasoning errors, logical
> fallacies, confusions, false information or false knowledge.
>
> Then, the concepts or facts presented are mixed up or
> misunderstood. An economic / financial example is confusing
> nominal return rates with inflation-adjusted return rates
> (money illusion)
>
> Origins of framing
>
> Framing can have two distinct origins, as it can be a personal
> cognitive bias or be an outside misinformation :
>
> * An internal / personal framing is done by the decider itself,
> it can be
> - either occasional (lack of attention, tunnel vision, but
> also emotional situations blocking the analytical mind),
> - or a result of the person's habit to look at information from
> a single narrow angle
> => Here two sub-possibilities : either the person has a personal
> cognitive or emotional bias, or the habit is common to a whole
> group or population, as a result of social learning. In the
> last case there is a joint phenomenon of internal and external
> framing as seen below.
>
> * An external framing: is the way the information is given by
> the media, an adviser, the social group, etc. to the decider,
>
> External framing can be 
> - either done involuntarily, sometimes because of pure
> incompetence from the author,
> - or launched voluntarily by the initiator(s) (manipulation,
> deception, neuro-linguistic).
> => Some hypes or demonizations are made just by using a word
> for another, rewording a negative concept into a positive way,
> or vice-versa (newspeak)
>
> Most people are "frame dependent". They limit their approach to
> one angle (tunnel vision). They select only one way (usually
> the one that is immediately apparent or that fits their
> one-sided beliefs) of defining questions they ask themselves,
> or of building their decisions (see limited heuristics,
> rationalizing).
> This narrow definition of the question, or the limited scope of
> their research; is conditioning their answer to it.
>
> The risks of framing
>
> In many life circumstances (look at the political debates before
> an election to find a flurry of examples of misleading
> presentations;-)), this narrow approach can be a source of wrong
> decisions. In money management and in economic behavior, the
> risk to follow unconsciously some red herring is very strong too.
>
> Specific cases
>
> * "Narrow framing" means people overlook the longer view and
> focus their perception on the immediate future (short term bias). 
> This is one of the reasons why putting money in pension schemes
> is usually mandatory, as most people would not spare enough
> voluntarily for their old days.
> * It is advised to use a "wealth frame" for investing decisions.
> This means to take into account all your present and expected
> wealth (assets, debts, expected charge and revenues) so as not
> to focus on a too narrow aspect.
>
> ** END **
>
> What are your thoughts and info on the topic ?
> Also, can the article be improved ?
> Thanks for your interest.
>
> Peter
>

Yes, that is why framing is difficult to translate in
other languages, French in my case, because there are
two notions and "cadrage mental" doesn't clearly describe
what it is about.

What I think is that framing covers both things,
* the exogenous and intentional one (manipulation)
* the endogenous and unintentional one (bounded
rationality).
Well, it could even be split in a four category matrix.

But normally the intentional one works mainly on people
who are prone to such unintentional fallacy, whatever
the reason (prior belief, lack of attention, emotional
content...). In other words, manipulation seems to be
the intentional use of framing on people prone to
unintentional framing.

Nicely said (or framed ;-)), hey?
Well, I don't know if I see things rightly (again, the
semantic puzzle). I think our group's members might help
to explain better.

Peter


--- In Behavioral-Finance@yahoogroups.com, "leif_ericssen"
<leif_ericssen@...> wrote:
>
> My 1st observation is really a question; is a frame in the
> Kahneman - Tversky meaning the same thing as a frame in the sense
of
> agenda setting and propaganda by politicos and spin doctors?
>
> Jan
>
> --- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
> <pgreenfinch@> wrote:
> >
> > Hi!
> >
> > Every month, I submit an article from the BF glossary,
> > for information, to start a debate on the topic and to get
> > your observations.
> >
> > This month I chose a classic: "Framing"
> > http://perso.orange.fr/pgreenfinch/bfglo/bfglo.framing.htm
> >
> > ** START **
> >
> > Framing is a biased way with which an issue, or an information,
> > is worded, described, perceived.
> > The formulation orientates the perception of the issue and the
> > direction of thoughts about it. It can change its analysis and
> > interpretations, lead to wrong ideas about it, and thus thwart
> > the conclusions and decisions (for example investment decisions).
> >
> > How framing is done
> >
> > To "frame" an issue is
> > * to narrow its definition or its presentation, by selecting
> > only one aspect,
> > * or to give a biased presentation of formulation, which
> > diverts the attention towards a specific interpretation
> >
> > Not only the facts presented or selected, but also, the
> > vocabulary that is used can play an important part in framing
> > (neuro-linguistic). Other elements than words can also change
> > the picture. For example, everybody knows the effect of how
> > the wares are presented in shop windows, or of the way people
> > dress.
> >
> > Examples of framing
> >
> > *  3 dollars a day seems less costly than 1095 dollars a year.
> > *  Saying "there is 50% chance of success" instead of "50%
> > chance to fail" could change a decision (the famous half-full
> > or half-empty glass).
> > *  Some framing are due to pure reasoning errors, logical
> > fallacies, confusions, false information or false knowledge.
> >
> > Then, the concepts or facts presented are mixed up or
> > misunderstood. An economic / financial example is confusing
> > nominal return rates with inflation-adjusted return rates
> > (money illusion)
> >
> > Origins of framing
> >
> > Framing can have two distinct origins, as it can be a personal
> > cognitive bias or be an outside misinformation :
> >
> > * An internal / personal framing is done by the decider itself,
> > it can be
> > - either occasional (lack of attention, tunnel vision, but
> > also emotional situations blocking the analytical mind),
> > - or a result of the person's habit to look at information from
> > a single narrow angle
> > => Here two sub-possibilities : either the person has a personal
> > cognitive or emotional bias, or the habit is common to a whole
> > group or population, as a result of social learning. In the
> > last case there is a joint phenomenon of internal and external
> > framing as seen below.
> >
> > * An external framing: is the way the information is given by
> > the media, an adviser, the social group, etc. to the decider,
> >
> > External framing can be 
> > - either done involuntarily, sometimes because of pure
> > incompetence from the author,
> > - or launched voluntarily by the initiator(s) (manipulation,
> > deception, neuro-linguistic).
> > => Some hypes or demonizations are made just by using a word
> > for another, rewording a negative concept into a positive way,
> > or vice-versa (newspeak)
> >
> > Most people are "frame dependent". They limit their approach to
> > one angle (tunnel vision). They select only one way (usually
> > the one that is immediately apparent or that fits their
> > one-sided beliefs) of defining questions they ask themselves,
> > or of building their decisions (see limited heuristics,
> > rationalizing).
> > This narrow definition of the question, or the limited scope of
> > their research; is conditioning their answer to it.
> >
> > The risks of framing
> >
> > In many life circumstances (look at the political debates before
> > an election to find a flurry of examples of misleading
> > presentations;-)), this narrow approach can be a source of wrong
> > decisions. In money management and in economic behavior, the
> > risk to follow unconsciously some red herring is very strong too.
> >
> > Specific cases
> >
> > * "Narrow framing" means people overlook the longer view and
> > focus their perception on the immediate future (short term bias). 
> > This is one of the reasons why putting money in pension schemes
> > is usually mandatory, as most people would not spare enough
> > voluntarily for their old days.
> > * It is advised to use a "wealth frame" for investing decisions.
> > This means to take into account all your present and expected
> > wealth (assets, debts, expected charge and revenues) so as not
> > to focus on a too narrow aspect.
> >
> > ** END **
> >
> > What are your thoughts and info on the topic ?
> > Also, can the article be improved ?
> > Thanks for your interest.
> >
> > Peter
> >
>

Framing biased could be divided into(i) internal
framing - (e.q., cognitive dissonance), and (ii)
external framing - (e.q., seeking pride).

Thanks
Djoko Wintoro



--- leif_ericssen <leif_ericssen@...> wrote:

> My 1st observation is really a question; is a frame
> in the
> Kahneman - Tversky meaning the same thing as a frame
> in the sense of
> agenda setting and propaganda by politicos and spin
> doctors?
>
> Jan
>
> --- In Behavioral-Finance@yahoogroups.com,
> "pgreenfinch"
> <pgreenfinch@...> wrote:
> >
> > Hi!
> >
> > Every month, I submit an article from the BF
> glossary,
> > for information, to start a debate on the topic
> and to get
> > your observations.
> >
> > This month I chose a classic: "Framing"
> >
>
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.framing.htm
> >
> > ** START **
> >
> > Framing is a biased way with which an issue, or an
> information,
> > is worded, described, perceived.
> > The formulation orientates the perception of the
> issue and the
> > direction of thoughts about it. It can change its
> analysis and
> > interpretations, lead to wrong ideas about it, and
> thus thwart
> > the conclusions and decisions (for example
> investment decisions).
> >
> > How framing is done
> >
> > To "frame" an issue is
> > * to narrow its definition or its presentation, by
> selecting
> > only one aspect,
> > * or to give a biased presentation of formulation,
> which
> > diverts the attention towards a specific
> interpretation
> >
> > Not only the facts presented or selected, but
> also, the
> > vocabulary that is used can play an important part
> in framing
> > (neuro-linguistic). Other elements than words can
> also change
> > the picture. For example, everybody knows the
> effect of how
> > the wares are presented in shop windows, or of the
> way people
> > dress.
> >
> > Examples of framing
> >
> > *  3 dollars a day seems less costly than 1095
> dollars a year.
> > *  Saying "there is 50% chance of success" instead
> of "50%
> > chance to fail" could change a decision (the
> famous half-full
> > or half-empty glass).
> > *  Some framing are due to pure reasoning errors,
> logical
> > fallacies, confusions, false information or false
> knowledge.
> >
> > Then, the concepts or facts presented are mixed up
> or
> > misunderstood. An economic / financial example is
> confusing
> > nominal return rates with inflation-adjusted
> return rates
> > (money illusion)
> >
> > Origins of framing
> >
> > Framing can have two distinct origins, as it can
> be a personal
> > cognitive bias or be an outside misinformation :
> >
> > * An internal / personal framing is done by the
> decider itself,
> > it can be
> > - either occasional (lack of attention, tunnel
> vision, but
> > also emotional situations blocking the analytical
> mind),
> > - or a result of the person's habit to look at
> information from
> > a single narrow angle
> > => Here two sub-possibilities : either the person
> has a personal
> > cognitive or emotional bias, or the habit is
> common to a whole
> > group or population, as a result of social
> learning. In the
> > last case there is a joint phenomenon of internal
> and external
> > framing as seen below.
> >
> > * An external framing: is the way the information
> is given by
> > the media, an adviser, the social group, etc. to
> the decider,
> >
> > External framing can be 
> > - either done involuntarily, sometimes because of
> pure
> > incompetence from the author,
> > - or launched voluntarily by the initiator(s)
> (manipulation,
> > deception, neuro-linguistic).
> > => Some hypes or demonizations are made just by
> using a word
> > for another, rewording a negative concept into a
> positive way,
> > or vice-versa (newspeak)
> >
> > Most people are "frame dependent". They limit
> their approach to
> > one angle (tunnel vision). They select only one
> way (usually
> > the one that is immediately apparent or that fits
> their
> > one-sided beliefs) of defining questions they ask
> themselves,
> > or of building their decisions (see limited
> heuristics,
> > rationalizing).
> > This narrow definition of the question, or the
> limited scope of
> > their research; is conditioning their answer to
> it.
> >
> > The risks of framing
> >
> > In many life circumstances (look at the political
> debates before
> > an election to find a flurry of examples of
> misleading
> > presentations;-)), this narrow approach can be a
> source of wrong
> > decisions. In money management and in economic
> behavior, the
> > risk to follow unconsciously some red herring is
> very strong too.
> >
> > Specific cases
> >
> > * "Narrow framing" means people overlook the
> longer view and
> > focus their perception on the immediate future
> (short term bias). 
> > This is one of the reasons why putting money in
> pension schemes
> > is usually mandatory, as most people would not
> spare enough
> > voluntarily for their old days.
> > * It is advised to use a "wealth frame" for
> investing decisions.
> > This means to take into account all your present
> and expected
> > wealth (assets, debts, expected charge and
> revenues) so as not
> > to focus on a too narrow aspect.
> >
> > ** END **
> >
> > What are your thoughts and info on the topic ?
> > Also, can the article be improved ?
> > Thanks for your interest.
> >
> > Peter
> >
>
>
>


__________________________________________________
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Dear All,

All those who would like to understand the basics of the financial
psychology...do read " the Psychology of finance". its a great book..
am sure all will agree who have read this book.

Coul anyone suggest me any more books on the similar pattern?

Thanks and Regards
Shalini



--

Hi!

Every month, I submit an article from the BF glossary,
for information, to start a debate on the topic and to get
your observations.

This month I chose a classic: "Framing"
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.framing.htm

** START **

Framing is a biased way with which an issue, or an information,
is worded, described, perceived.
The formulation orientates the perception of the issue and the
direction of thoughts about it. It can change its analysis and
interpretations, lead to wrong ideas about it, and thus thwart
the conclusions and decisions (for example investment decisions).

How framing is done

To "frame" an issue is
* to narrow its definition or its presentation, by selecting
only one aspect,
* or to give a biased presentation of formulation, which
diverts the attention towards a specific interpretation

Not only the facts presented or selected, but also, the
vocabulary that is used can play an important part in framing
(neuro-linguistic). Other elements than words can also change
the picture. For example, everybody knows the effect of how
the wares are presented in shop windows, or of the way people
dress.

Examples of framing

* 3 dollars a day seems less costly than 1095 dollars a year.
* Saying "there is 50% chance of success" instead of "50%
chance to fail" could change a decision (the famous half-full
or half-empty glass).
* Some framing are due to pure reasoning errors, logical
fallacies, confusions, false information or false knowledge.

Then, the concepts or facts presented are mixed up or
misunderstood. An economic / financial example is confusing
nominal return rates with inflation-adjusted return rates
(money illusion)

Origins of framing

Framing can have two distinct origins, as it can be a personal
cognitive bias or be an outside misinformation :

* An internal / personal framing is done by the decider itself,
it can be
- either occasional (lack of attention, tunnel vision, but
also emotional situations blocking the analytical mind),
- or a result of the person's habit to look at information from
a single narrow angle
=> Here two sub-possibilities : either the person has a personal
cognitive or emotional bias, or the habit is common to a whole
group or population, as a result of social learning. In the
last case there is a joint phenomenon of internal and external
framing as seen below.

* An external framing: is the way the information is given by
the media, an adviser, the social group, etc. to the decider,

External framing can be 
- either done involuntarily, sometimes because of pure
incompetence from the author,
- or launched voluntarily by the initiator(s) (manipulation,
deception, neuro-linguistic).
=> Some hypes or demonizations are made just by using a word
for another, rewording a negative concept into a positive way,
or vice-versa (newspeak)

Most people are "frame dependent". They limit their approach to
one angle (tunnel vision). They select only one way (usually
the one that is immediately apparent or that fits their
one-sided beliefs) of defining questions they ask themselves,
or of building their decisions (see limited heuristics,
rationalizing).
This narrow definition of the question, or the limited scope of
their research; is conditioning their answer to it.

The risks of framing

In many life circumstances (look at the political debates before
an election to find a flurry of examples of misleading
presentations;-)), this narrow approach can be a source of wrong
decisions. In money management and in economic behavior, the
risk to follow unconsciously some red herring is very strong too.

Specific cases

* "Narrow framing" means people overlook the longer view and
focus their perception on the immediate future (short term bias). 
This is one of the reasons why putting money in pension schemes
is usually mandatory, as most people would not spare enough
voluntarily for their old days.
* It is advised to use a "wealth frame" for investing decisions.
This means to take into account all your present and expected
wealth (assets, debts, expected charge and revenues) so as not
to focus on a too narrow aspect.

** END **

What are your thoughts and info on the topic ?
Also, can the article be improved ?
Thanks for your interest.

Peter

Never heard of "range estimate aversion"?
Don't worry, I just coined the phrase, after hearing that
next year GDP will grow 2.4%, that the candidate XXX at
next year presidential election is given 33% votes in
the first round by a pollster, and that the nest quarterly
earnings per share expected for YYY is 53 cents

Thus I defined a decider's "range estimate aversion" as
a kind of framing. The fact that economic, financial,
managerial, political deciders, and also individual investors,

* Either determine a precise number (for GDP growth, sales,
stock price...) instead of a range of values that would allow
to see the various possibilities and risks among which to
build a strategy. They tend to focus on what they expect
will happen or not, and forget to imagine other possibilities.

* Or expect from experts and analysts to be given such a
precise number instead of a choice of scenarios

To reduce an estimate to one number can be classified as
a type of framing that gives the deciders an illusion of
certainty and water down their appreciation of risk.
Also, if things turn bad, it allows them to attribute
the responsibility on the expert, forgetting that the role
of the decider is to make choice, not obey to experts.

Now, what do you think and did some member heard about
some studies that would corroborate my home made concept?

Btw, wishing you a lot of home made cookies at the approach
of christmas, new year or other solstice festivities, sending
you my full range of season's greeting ;-)

Peter

__________________________________________________
Correo Yahoo!
Espacio para todos tus mensajes, antivirus y antispam ¡gratis!
Regístrate ya - http://correo.espanol.yahoo.com/

--- In Behavioral-Finance@yahoogroups.com, "Shalini Kalra Sahi"
<kalra.shalini@...> wrote:
>
> Dear All,
>
> All those who would like to understand the basics of the financial
> psychology...do read " the Psychology of finance". its a great book..
> am sure all will agree who have read this book.
>
> Coul anyone suggest me any more books on the similar pattern?
>
> Thanks and Regards
> Shalini

Hi, Shalini. Seemed to me closer to technical analysis than
to psychology, but there are some interferences.
Peter

--- In Behavioral-Finance@yahoogroups.com, rabah zohra <rabahzohra@...>
wrote:
>
> hi peter,
>   thanks for information
>   i have to ask you a question; what type of relationship between
the "narrow framing" bias and the"disposition effect" bias? please can
you explain me?
>   thank you in advance
>   with my best regards

I don't see much relation, as the disposition effect is the
reluctance to sell an asset, at least if you lose money on it.
But maybe you have seen another definition of narrow framing.
Peter

That is a way to put it, Arturo, claro que si ;-)

And as expectations are often based on past references
I suspect many expert predictions just extrapolate past
numbers without real future scenario analysis, which
could explain why previsionist are sometimes caught
with their pants down when situations change.
Thus I would say that it is often also an anchoring on
past data.

Another thing is peer pressure, analysts don't find it
safe to give previsions that differ from the consensus.

Peter

--- In Behavioral-Finance@yahoogroups.com, Arturo Gutierrez
<argujo@...> wrote:
>
> Peter:
>
> Does not sound very similar to "anchoring" to an expected number?
> Arturo
>

--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
[  ]
> Another thing is peer pressure, analysts don't find it
> safe to give previsions that differ from the consensus.
>
> Peter

For securities analysts, estimating earnings is a tricky balancing
act.  The real pressure is to not be very wrong with earnings
estimates and to write reports that investors want to read and trade
on.

For sell-side analysts who work at investment banks and brokerage
firms, the whole thing is about generating order flow and
underwriting new issues.  In general, an analyst's objective is to
provide an earnings estimate that will be very close to actual
earnings, just a little lower.

What an analyst doesn't want is a too low estimate that anyone could
make and that would be insulting to the company's management.  And
what an analyst Really doesn't want to do is an estimate that is far
above the actual earnings.

Even if a very low estimate is reasonable and correct, it won't buy
the analyst much because people will react to a negative report with
a quick burst of sales and short sales or avoiding the stock. Maybe
a large price drop if the analyst is known, but that's it.  And the
company's management is pissed off at the analyst's firm.  This has
to be weighted against any future street cred for calling it right.

And if the low-ball estimate is reasonable and *incorrect*, it will
be a disaster.

An estimate that is far ( >10% ) above the actual earnings is bad
for the analyst because it reflects on that analyst's competance.
So making a high earnings estimate, even if realistic is risky,
although the rewards for being a correct optimist are much greater
than being a correct pessimist.

Basically, an analyst hit with a let-down (too high estimate) is
better off if they were in good company and other analysts were hit
too. So there is some incentive for clustering around a consenseless
target. If done cleverly, they can imply that the company's
management misled the Street and get the pressure off of themselves
for being wrong.  That's the main reason why analysts meet with
managemant and seek 'guidance' on earnings expectations.

You can just imagine how a naive management can get burned bad by
being opimistic and talking freely to analysts.

Jan

Peter--

I like "range estimate aversion".  Congratulations on coining the
phrase.

As an investment manager/analyst, I use sell-side analysts' point
estimates to create my own range--  of eps estimates, for example.

Analysts don't create ranges because they wouldn't have anything
to "sell" to the buy-side.  Also, as you mention, a single estimate
gives an illusion of certainty.  I have found that both the sell-
side and buy-side have a problem dealing with a range of probable
outcomes--  the implication is that they might not actually be
correct in their single point work!  Few in the investment world
want to acknowledge that there is rampant "illusion" in the industry!

Best wishes.

Steve Gammage




--- In Behavioral-Finance@yahoogroups.com, "pgreenfinch"
<pgreenfinch@...> wrote:
>
> Never heard of "range estimate aversion"?
> Don't worry, I just coined the phrase, after hearing that
> next year GDP will grow 2.4%, that the candidate XXX at
> next year presidential election is given 33% votes in
> the first round by a pollster, and that the nest quarterly
> earnings per share expected for YYY is 53 cents
>
> Thus I defined a decider's "range estimate aversion" as
> a kind of framing. The fact that economic, financial,
> managerial, political deciders, and also individual investors,
>
> * Either determine a precise number (for GDP growth, sales,
> stock price...) instead of a range of values that would allow
> to see the various possibilities and risks among which to
> build a strategy. They tend to focus on what they expect
> will happen or not, and forget to imagine other possibilities.
>
> * Or expect from experts and analysts to be given such a
> precise number instead of a choice of scenarios
>
> To reduce an estimate to one number can be classified as
> a type of framing that gives the deciders an illusion of
> certainty and water down their appreciation of risk.
> Also, if things turn bad, it allows them to attribute
> the responsibility on the expert, forgetting that the role
> of the decider is to make choice, not obey to experts.
>
> Now, what do you think and did some member heard about
> some studies that would corroborate my home made concept?
>
> Btw, wishing you a lot of home made cookies at the approach
> of christmas, new year or other solstice festivities, sending
> you my full range of season's greeting ;-)
>
> Peter
>

--- In Behavioral-Finance@yahoogroups.com, rabah zohra <rabahzohra@...>
wrote:
>
> hi peter,
> thanks for information
> i have to ask you a question; what type of relationship between
the "narrow framing" bias and the"disposition effect" bias? please can
you explain me?
> thank you in advance
> with my best regards

I don't see much relation, as the disposition effect is the
reluctance to sell an asset, at least if you lose money on it.
But maybe you have seen another definition of narrow framing.
Peter

__________________________________________________
Do You Yahoo!?
Tired of spam? Yahoo! Mail has the best spam protection around
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Thanks to all members for your faithful interest
to our group in 2006.

Best wishes to you all for 2007!

Let us ride happily together the January effect,
Monday effects, ends of month effects and all
other BF calendar effects!

Not to forget the sunshine effects. Heard they
are ...cool for investors. Hope it is the same
for the planet ;-).

Peter

Hi, dear members and visitors!

I'm glad to send you our group's 80th month newsletter,
First let me renew my best wishes for you all for 2007.

As for our group, we might explore new grounds, thanks for
example to the findings of neurofinance. Although there is
no certainty that looking at the fight between brain cells
will help crack the code of all the mysteries of finance.
Even Dan Brown did not dare to tackle the most famous one,
the "equity risk premium puzzle" ;-)

1) Monthly activity

Our membership (subscribers / unsubscribers balance) grew
by about 5 with ca 1645 unbouncing members.
We had 25 messages, and the total is now a bit over 7735.
Yes, sometime I fantasize about round or - in this case -
half round numbers. A little bias not very consistent with
my post about range estimate aversion, hey ? ;-))

Welcome to new members. And thanks to all contributors!

Our sister group, Finance-Academy stays at ca 325 members
http://groups.yahoo.com/group/Finance-Academy

2) Reminder : Two poll are still running at
http://finance.groups.yahoo.com/group/Behavioral-Finance/polls
Thanks for your votes.

3) Our free BF resources at your fingertips 24/7:

* Your permanently updated and improved BF glossary
500+ definitions, many of them as detailed articles.
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.a.htm

* Martin Sewell's academic treasure chest in BF topics,
that site is a must for students and researchers:
http://www.behaviouralfinance.net/

* Your behavioral stockpricer:
http://perso.orange.fr/pgreenfinch/pricer.htm

* Our group charter
http://finance.groups.yahoo.com/group/Behavioral-Finance/files/
(click BF Group charter.doc)
also available at:
http://perso.orange.fr/pgreenfinch/befigrouppolicy.htm

** Remember, folks, that you need a *yahoo ID/profile* to access
all Yahoo group's resources (polls, links and files),
To get it, click "account info" (in the group's homepage or your
"my groups" page) and fill in the info you deem appropriate

Wishing for many quality info and debates in this new month
as a good start for the year.

Peter

Hi all dear Friends,

 

     I'm a new PhD Student of Finance and the area I'm interested in is Portfolio Management, especially about Optimal Selection. I don't want to do my thesis in financial mathematics but my econometrics is OK.I would be very appreciated if any of you could give me some advice for research topics about my interests.

Best regards,

G.Mansourfar

Hi Mansourfar

The following paper may be useful for you

At-Sahalia, Y. & Brandt, M.
Variable selection for portfolio choice
Journal of Finance, 2001, 4, 1297-1355

Best Regards,
Jing

--- In Behavioral-Finance@yahoogroups.com, "G.Mansourfar"
<mansour325@...> wrote:
>
>   Hi all dear Friends,
>
>        I'm a new PhD Student of Finance and the area I'm interested
in is Portfolio Management, especially about Optimal Selection. I
don't want to do my thesis in financial mathematics but my
econometrics is OK.I would be very appreciated if any of you could
give me some advice for research topics about my interests.
>   Best regards,
>   G.Mansourfar
>
>
> ---------------------------------
> Finding fabulous fares is fun.
> Let Yahoo! FareChase search your favorite travel sites to find
flight and hotel bargains.
>

Hi!

Every month, I submit an article from the BF glossary,
for information, to start a debate on the topic and to get
your observations.

This month, as I hinted in my new year newsletter, I
chose mystery : I chose a classic: "equity risk premium puzzle"
that can be found in the "risk" page:
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm

** START **

Definition: the risk premium is the difference in returns between
risky investment (or example stocks) and those considered safe (for
example bonds with large markets issued by highly solvent countries)

Risky investments are supposed to earn more than safer ones.
Investors usually want a better return for assets they consider
risky.
This difference can be said to be a measurement of the average risk
aversion for all investors in a given period.

The effect on prices

As said in the risk aversion article, an effect on returns translates
into an opposite effect on prices.
Mathematically; for a given income I, the return R=I/P of an asset is
higher when its price P is lower. Risky assets are, or should, be
priced lower than safe ones.

Normally, in stock markets, the risk premium is measured for the
whole market (stock index), while specific risks for a given stock
are taken into account by the beta coefficient.

The puzzle(s)

The risk premium, and more specifically the "equity premium" that is
related to stock investing, is a standard finance notion that raises
various puzzles

The first issue is that the equity risk premium can be measured only
ex-post, by comparing the performances (or example dividends + price
rises or stocks vs. essentially coupons or bonds). The current
premium, which should be based on future return expectations, can
only be estimated.

Another puzzle is that the premium is not a constant but a variable,
which might reflect the fact that the collective "risk aversion"
varies. It even seem to be negative for some investments, or during
some periods.

Not only you cannot really trust "historical" risk premium data, but
also all this raises several questions:

- Does the risk premium theory reflect the real world? Is the premium
related to the real risk? Or to be more precise to the uncertainty.
You know, what you cannot even measure.
- As this premium is unstable, are its variation's orientation and
its extreme value predictable?
- How high should the "normal" risk premium be in average ? But why
should the risk premium match a precise number, which would suppose
that people aversion for risk is intangible and could be predefined
for ever?
- Btw, how to measure current risk premia ? A caricature - widely
used for stocks - is to take the difference between the current
earnings yield (the reverse of the P/E) and the sovereign bonds
interest rate. Numerology at its best ! If you know what is dividend
discounting or cash flow discounting you must wonder, as I do, if you
live in the right planet.

The specific "equity premium puzzle"

Definition: the "equity premium puzzle" (or "equity risk premium
puzzle", see that phrase) is the risk premium included in stock
prices and returns compared to "riskless assets".(taking sovereign
bonds as a reference).
For this specific version of the risk premium, the puzzle lies in the
fact that when you invest in equities in a diversified portfolio and
for the long term, the risk is normally neutralized.

Here appears several puzzles:
* The existence of an equity premium does not look rational as it
seems that equities give better return without real risk.
* If that premium is large, it shows an excessive risk aversion by
investor.
* What if the assumption that diversified portfolio is less risky
than investing in sovereign bonds was bit far fetched ? .
* What if the EP had nothing to do with risk aversion (*) and was
hiding other, more complex phenomena (**)?
* Last but not least, what if the equity risk premium was a
statistical illusion?

(*) A person who invests for the long term (for retirement for
example) should prefer to do it on equities than in bonds. They call
the reluctance to do it, by preferring bonds anyway, the myopic loss
aversion.
(**) See underreaction, overreaction, image coefficient..;

An added problem for equity premia is that there are many ways to
calculate stock returns (taking into accounts dividends, cash
earnings, earnings, stock price gains, etc.) in order  Depending on
the calculation method, the average historical EP is said to be
somewhere between 3-4 % and 7-8 %).
In reality, those "puzzles" may overlook the facts some rational
motivations would explain and justify the equity risk premium due to
the following facts:
-  The short term risk is a real risk: to lose money fast is not
better - it is even worse - than losing it slowly!
-  In "secular bear markets" you might need to wait during the time
span of a full generation before getting even and receiving a return
comparable to other assets.

** END **

What are your thoughts and info on the topic?
Well, are you ...puzzled?
Also, can the article be improved ?
Thanks for your interest.

Peter

Hi!

Every month, I submit an article from the BF glossary,
for information, to start a debate on the topic and to get
your observations.

This month, as I hinted in my new year newsletter, I
chose mystery : I chose a classic: "equity risk premium puzzle"
that can be found in the "risk" page:
http://perso.orange.fr/pgreenfinch/bfglo/bfglo.risk.htm

** START **

Definition: the risk premium is the difference in returns between
risky investment (or example stocks) and those considered safe (for
example bonds with large markets issued by highly solvent countries)

Risky investments are supposed to earn more than safer ones.
Investors usually want a better return for assets they consider
risky.
This difference can be said to be a measurement of the average risk
aversion for all investors in a given period.

The effect on prices

As said in the risk aversion article, an effect on returns translates
into an opposite effect on prices.
Mathematically; for a given income I, the return R=I/P of an asset is
higher when its price P is lower. Risky assets are, or should, be
priced lower than safe ones.

Normally, in stock markets, the risk premium is measured for the
whole market (stock index), while specific risks for a given stock
are taken into account by the beta coefficient.

The puzzle(s)

The risk premium, and more specifically the "equity premium" that is
related to stock investing, is a standard finance notion that raises
various puzzles

The first issue is that the equity risk premium can be measured only
ex-post, by comparing the performances (or example dividends + price
rises or stocks vs. essentially coupons or bonds). The current
premium, which should be based on future return expectations, can
only be estimated.

Another puzzle is that the premium is not a constant but a variable,
which might reflect the fact that the collective "risk aversion"
varies. It even seem to be negative for some investments, or during
some periods.

Not only you cannot really trust "historical" risk premium data, but
also all this raises several questions:

- Does the risk premium theory reflect the real world? Is the premium
related to the real risk? Or to be more precise to the uncertainty.
You know, what you cannot even measure.
- As this premium is unstable, are its variation's orientation and
its extreme value predictable?
- How high should the "normal" risk premium be in average ? But why
should the risk premium match a precise number, which would suppose
that people aversion for risk is intangible and could be predefined
for ever?
- Btw, how to measure current risk premia ? A caricature - widely
used for stocks - is to take the difference between the current
earnings yield (the reverse of the P/E) and the sovereign bonds
interest rate. Numerology at its best ! If you know what is dividend
discounting or cash flow discounting you must wonder, as I do, if you
live in the right planet.

The specific "equity premium puzzle"

Definition: the "equity premium puzzle" (or "equity risk premium
puzzle", see that phrase) is the risk premium included in stock
prices and returns compared to "riskless assets".(taking sovereign
bonds as a reference).
For this specific version of the risk premium, the puzzle lies in the
fact that when you invest in equities in a diversified portfolio and
for the long term, the risk is normally neutralized.

Here appears several puzzles:
* The existence of an equity premium does not look rational as it
seems that equities give better return without real risk.
* If that premium is large, it shows an excessive risk aversion by
investor.
* What if the assumption that diversified portfolio is less risky
than investing in sovereign bonds was bit far fetched ? .
* What if the EP had nothing to do with risk aversion (*) and was
hiding other, more complex phenomena (**)?
* Last but not least, what if the equity risk premium was a
statistical illusion?

(*) A person who invests for the long term (for retirement for
example) should prefer to do it on equities than in bonds. They call
the reluctance to do it, by preferring bonds anyway, the myopic loss
aversion.
(**) See underreaction, overreaction, image coefficient..;

An added problem for equity premia is that there are many ways to
calculate stock returns (taking into accounts dividends, cash
earnings, earnings, stock price gains, etc.) in order Depending on
the calculation method, the average historical EP is said to be
somewhere between 3-4 % and 7-8 %).
In reality, those "puzzles" may overlook the facts some rational
motivations would explain and justify the equity risk premium due to
the following facts:
- The short term risk is a real risk: to lose money fast is not
better - it is even worse - than losing it slowly!
- In "secular bear markets" you might need to wait during the time
span of a full generation before getting even and receiving a return
comparable to other assets.

** END **

What are your thoughts and info on the topic?
Well, are you ...puzzled?
Also, can the article be improved ?
Thanks for your interest.

Peter