Economic Rockstar

Connecting Brilliant Minds in Economics and Finance

024: Greg Davies on Behavioral Finance and Controlling Your Emotions When Making Trading Decisions

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024: Greg Davies on Behavioral Finance and Controlling Your Emotions When Making Trading Decisions

Greg Davies is Managing Director and Head of Behavioral Finance at Barclays.  He joined the firm in December 2006 to develop and implement commercial applications drawing on behavioural portfolio theory, the psychology of judgment and decision making, and decision sciences.

Today Greg leads a global team of behavioural and quantitative finance specialists, and is responsible for the design and global implementation of Barclays’ Investment Philosophy.

Greg is an Associate Fellow at Oxford University’s Saïd Business School and his first (co-authored) book, ‘Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory’, was published in January 2012.

He is co-curator and co-creator of Open Outcry – a reality opera based on the stock market trading floor.

Greg has authored papers in multiple academic disciplines, presents at academic and industry conferences, and is a frequent media commentator on Behavioural Finance.  He is an Editorial Board Member of the Journal of Behavioural and Experimental Finance.

Greg studied at the University of Cape Town and obtained a degree in Economics, Philosophy and Finance. He followed this with an MPhil in Economics and a PhD in Decision Theory and Behavioural Finance from the University of Cambridge.

Economic Themes:

In this interview, Greg mentions and discusses:

Behavioral economics, behavioral finance, rationality, irrational behavior, heuristics, cognitive biases, system 1, system 2, homo economicus, trade-off, home bias, familiarity bias, risk, return, portfolio, efficient frontier, stochastic model, trading floor, noise, herding, bubbles, booms, bust, returns, standard deviation, deterministic model, decision theory, expected utility theory, mean variance and portfolio theory.

Economists:

In this interview, Greg mentions:

Danial Kahneman, Amos Tversky, Terence Odean, Warren Buffet, Charlie Munger and Harry Markowitz.

Influencers:

Jon Elster and Amos Tversky.

Advice:

Be multi-disciplinary. Look for links between fields. Be continuously curious.

Keep learning. Stay curious. Say ‘yes’ to things that are outside your comfort zone.

Find out:

  • what is Behavioral Economics/Finance
  • the disconnection between economics and psychology.
  • how Kahneman and Tversky were ‘swimming up-stream’ to bring common sense to economics.
  • why viewing the world through biases is harmful to behavioral finance.
  • why the ever-increasing list of biases may not be good for the behavioral finance field.
  • about System 1 and System 2 as popularised by Daniel Kahneman.
  • why it’s good to allow emotions to part of the portfolio decision-making process.
  • how to acquire the emotional comfort you need for your long-term financial objectives.
  • how to buy emotional insurance for your long-term investment portfolio.
  • how to avoid costly short-term emotional mistakes.
  • how psychometric tests can extract measures of financial personality.
  • why a set of nudges are designed to help high net-worth individuals to make better decisions.
  • how to build a tailored portfolio to meet your clients needs.
  • why you should consider including expected anxiety into your portfolio building along with risk and return.
  • what an opera experiment has to do with replicating the open outcry system of a trading floor.
  • how music can control your emotions while trading markets.
  • how Barclays Capital are improving the understanding of their clients by turning the lens on themselves.

Behavioral economics is the combination of finance theory and behavioral psychology. It’s about trying to understand how people actually do go about making financial decisions and, as a result, how we might make them better financial decisions.

Problems with Biases in Behavioral Finance:

  • Biases are only often biases if you view them through the lens of what economic theory very narrowly and mathematically deems to be rational.
  • There’s nothing irrational about having the need for a  short-term immediate emotional comfort.
  • A lot of deviations from narrow economic thinking are not irrational at all. They are perfectly reasonable. It is just that other people are bringing other objectives to bear on the decision.
  • The other problem is the tendency to look at the world through a list of biases.

Classical Finance would typically remove irrational behavior from its theories and models. However, the position of Behavioral Finance is much more subtle. As humans, we need emotional comfort. We need to be comfortable with the decisions we make and with the portfolio we hold. There is nothing irrational about that.

You need to find a way of not switching off your emotions but utilising them effectively – Greg Davies

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Emotions are actually a very good source of information for us if we use them in a thoughtful way – Greg Davies

Resources:

Farnam Street by Shane Parish 

Recommended Books:

Where To Find Greg Davies:

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021: Paul Dolan on the Economics of Happiness

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021: Paul Dolan on the Economics of Happiness

Paul Dolan is an internationally renowned expert on happiness, behaviour and public policy. He is currently a Professor of Behavioural Science in the Department of Social Policy at the London School of Economics and Political Science.

Paul has previously held academic posts at York, Newcastle, Sheffield and Imperial and he has been a visiting scholar at Princeton University, working with Daniel Kahneman.

Professor Dolan has over 100 peer-reviewed publications which cover many topics including behavioural science, subjective wellbeing, equity in health and health valuation.

Paul is currently a Member of the World Economic Forum Panel on Behavioural Science, the Chief Academic Advisor on Economic Appraisal for the UK Government’s Economic Service. He is also a member of National Academy of Sciences Panel on Wellbeing and of the Measuring National Wellbeing Advisory Forum for the Office for National Statistics in the UK.

Paul is the author of ‘Happiness by Design’.

Economic Themes:

In this interview, Paul mentions and discusses:  behavioral economics, happiness, nudging, trade-off, pleasure-purpose principle, production function, utility models, causal relationships, priming effects, System 1, System 2

Economists:

In this interview, Paul mentions: Daniel Kahneman, Amos Tversky, Irving Fischer and Gregory Mankiw.

“2,500 years of ethical discourse hasn’t resolved the question what is the source of happiness” – Paul Dolan

Find Out:

  • how Paul evolved from a health economist to a behavioral economist.
  • how many years of your life would you be willing to give up to avoid being anxious or being down.
  • if Aristotle and other philosophers are right in saying that happiness can only be defined on a death-bed when reflecting upon your life.
  • how to create a pleasure-purpose balance that’s right for you.
  • how you can use the production function process to produce happiness.
  • what is this production process that makes us happy.
  • if money makes you happier.
  • how happiness studies influence policy decision-making.
  • about the limitations to happiness research and what can be done to make better research.
  • what nudging is.
  • how nudging by policy-makers can make you happier.
  • about the morality of nudging.
  • how supermarkets can nudge you into buying their breads and cakes.
  • why self-help books are a waste of money as they try to change your mindset.
  • why Paul’s book, ‘Happiness By Design’ will help you to change what you do.
  • about Paul’s ‘3 Pillars of Happiness’ – Deciding, Designing and Doing.
  • how designing your life to make things simple and easy can help you achieve your goals.
  • about the essence of mindfulness.
  • why people who are easily distracted are more likely to be less happy.
  • if your phone can make you unhappy and what you should do about it.
  • why Paul is a ‘Happy Hammer’ (West Ham fan) despite never winning the league.
  • how the power of ‘hope’ can make you happy by allowing your imagination run freely.

Pleasure-Purpose Principle

Alongside pleasure sits purpose. Happy lives are ones that have a good balance between experiences that are pleasurable on the one hand and purposeful on the other. You need to find out the right balance between pleasure and purpose that is right for you.

The creation of happiness is like a product function of a firm. A firm uses inputs, puts them through a production process to create outputs.  A person can equally use inputs like money, marriage, sex, jobs and watching television that are stimuli and we can convert them into happiness by a production process.

What is that production process? According to Paul this production process is called ‘Attention’. Attention is the ‘glue’ that keeps our lives together in terms of behaviour and happiness. The answer to the question ‘Does money make you happier?’ depends on how much attention you pay it.

“Most of economic modelling is based on looking at what people do, not what people say”

Challenges with Happiness Economics: “A lot of what we think we know comes from making inferences from associations. We need to to do more research and field experiments where we look at the causal impact of interventions on people’s happiness.”

You can beg, borrow and steal money, but you’re never going to get time that’s lost – Paul Dolan

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Lost happiness is lost forever – Prof Paul Dolan

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Nudging

Nudging can sometimes be overt and sometimes covert. It can take the form of financial incentives or below-conscious stimuli such as sounds, tastes and smells. The latter is known as priming effects.

According to Paul Dolan, the definition of a successful nudge is one where people, who are being nudged toward a particular direction with the expectation that they would be better-off, become happier as a result of being nudged.

Policy-makers assume after a nudge that people are better off, but research hasn’t captured the after-effects of these nudges to find out if they are indeed better off. Paul is all for designing nudges that make people happier, not by how he judges how they should be happier but according to what large datasets tell him what affects people’s happiness.

Listen to Paul’s 3 Pillars of Happiness: Deciding, Designing and Doing 

The Essence of Mindfulness: “We’re generally happier when we’re paying attention to what we’re doing and who we’re doing it with – living in the moment” – Paul Dolan.

“When you’re switching activities, your brain is using energy and it makes you more tired and less happy” – Paul Dolan.

“Being a football fan is a bit like faith. You can’t really change it once you’ve got it” – Paul Dolan.

Recommended Book:

Where To Find Paul Dolan:

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