+ All Categories
Home > Documents > Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad...

Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad...

Date post: 01-Apr-2015
Category:
Upload: jeffrey-maltman
View: 212 times
Download: 0 times
Share this document with a friend
Popular Tags:
29
Behavioral Finance at JP Behavioral Finance at JP Morgan Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany April, 2010
Transcript
Page 1: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Finance at JP Behavioral Finance at JP MorganMorgan

Managerial Finance Presentation

Presented by

Hussein Elgarhy

&

Fouad Ellaithy

Supervised by

Prof. Dr. Mustafa Eldewany

April, 2010

Page 2: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

AgendaAgenda

Behavioral Finance * Why/What is BF

BF Characteristics Over Confidence / Loss aversion

Prospect Theory

The Weighting Function

JP Morgan **

BF At JP Morgan Over Confidence / Loss aversion

BF Implementation

JPM Branded BF Fund

Top JPM BF Funds Updated Status

* Behavioral Finance: BF** JP Morgan: JPM

Slide 1

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Page 3: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Why Behavioral Finance?

If we always behaved rationally…

Nobody would ever sell stocks in a panic at the first sign of trouble

Nobody would ever buy stocks (or other investments) based on hunches,

hot tips or media hype

Nobody would ever keep money in the bank instead of using it to pay off

high-interest credit card balances

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Page 4: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Finance Behavioral Finance provides an ‘overlay’ to the Standard Theory.

Theory It provides a framework to understand ‘non-rational’ investor and market behaviors…

Investors

Are not totally rational

Often act based on imperfect information

Make “non-rational” decisions in predictable ways

Markets

May be difficult to beat in the long term

In the short term, there are anomalies and excesses

The two aspects of behavioral finance are:

The behavior of investors

The behavior of markets© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Page 5: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Our Brains affect on Financial Decisions

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

•Fear Vs Greed •Dough Vs Gain

Page 6: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Finance Cont’

Behavioral Finance is a reflection to extremes we see in Efficient Market Theory or in Mathematical Finance.

It is not just Behavioral Psychology applied to finance but also includes more broad social aspects which are not related to anything fundamental.

Stocks Market Price

Stocks Dividends

1880 1900 1920 2000

Page 7: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Characteristics

Loss aversion

Media response

Disposition effect

Herding

Narrow framing

Optimism

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Mental accounting

Overconfidence

Regret

Anchoring

Hindsight bias

Recency

Page 8: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Characteristics “ JP Morgan focus “

Loss aversion

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Overconfidence

Page 9: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Over Confidence

What is the weight of Status of Liberty -in Tons- ?

Population of Turkey -2008- ?

Size of Sahara Desert -Sq meter- ?

Page 10: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Over Confidence

What is the weight of Status of Liberty -in Tons- ? 252 Tons

Page 11: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Over Confidence

What is the weight of Status of Liberty -in Tons- ? 252 Tons

Population of Turkey -2008- ? 73,914,260

Page 12: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Over Confidence

What is the weight of Status of Liberty -in Tons- ? 252 Tons

Population of Turkey -2008- ? 73,914,260

Size of Sahara Desert -Sq meter- ? 3.5 Million Sq meter

Page 13: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

In year 1979 Daniel Kahneman & Amos Tversky published there article about Prospect Theory as a psychologically realistic alternative to Expected Utility Theory.

There is a discontinuity in slope which means we value losses more than we value gains given an equal probability for both. In contrary to EUF, here we are always at the reference point exaggerate in our minds the importance of deviations from where we are. This is not rational! So losses tend to dominate so you don’t want to take the bet.

Expected Utility Function Value Function

Prospect Theory

Page 14: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

The Weighting Function

Named after the French economist Charles Allais, the Allais paradox illustrates thinking that violates the Expected Utility Theory:

Given these two prospects

Which one you choose?

Probability Gain

25% $3000

20% $4000

Page 15: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

The Weighting Function Cont’

Named after the French economist Charles Allais, the Allais paradox illustrates thinking that violates the Expected Utility Theory:

Given these two prospects

Which one you choose?

Most people would choose the 20% & $4000

Probability Gain

25% $3000

20% $4000

Page 16: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

What if you have

Which one you choose ?

Probability Gain

100% $3000

80% $4000

The Weighting Function Cont’

Page 17: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

What if you have

Which one you choose ?

Most people would choose the 100% & $3000 because we prefer certainty. This contradict with the EUF theory.

Probability Gain

100% $3000

80% $4000

The Weighting Function Cont’

Page 18: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

The Weighting Function Cont’

Kahneman & Tversky said we weight probabilities in our minds in a distortion way. They stated that we emotionally minimize the differences between probabilities if they are close.

Page 19: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

JP Morgan

J.P. Morgan Chase & Co. is one of the oldest financial services firms in the world. It has operations in 60 countries. It is a leader in financial services with assets of $2 trillion.

J.P Morgan manages clients’ assets through three key business units:

Private Bank High net worth individual (26 counties)

Private Client Services (PCS) Client with < $ 25M in Assets

Asset Management Developing financial products for retail and institutional investors

JPM was the seventh largest asset management company in the world in 2005

Page 20: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Behavioral Finance at JP Morgan They emphasis on two behavioral Biases:

Over confidence JPM funds systematically overweight value stocks, means that our

investment behavior is changed. We are forced to focus on out of fashion stocks that we wouldn’t naturally have bothered with and that means that we cannot fall into the same overconfidence trap.

Loss Aversion Our approach requires a systematic tilt to momentum, forcing us to run

our winners and cut our losers. It also forces our investors to re-evaluate stocks which have done well for a long time but are now starting to disappoint

Page 21: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

The implementation of the BF investment philosophy had three parts:

Stock selection A quantitative stock selection model is used to rank stocks based on behavioral

characteristics

Portfolio construction Portfolio construction involved maximizing exposure to stocks with value and

momentum, while controlling other risk exposures, such as overall risk, sector exposures

Execution. In our portfolios, stocks are systematically combined in such a way as to produce a

barbell portfolio which is cheaper than the market and has better momentum than the market - a kind of “super-stock.”

Behavioral Finance Implementation

Page 22: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

JPM Branded BF Fund Intrepid Funds

Intrepid America

Intrepid Growth

Intrepid Value

Intrepid Multi Cap

They Capitalize on the emotions that often cause people to make poor investment decisions

Their performance had been impressive Example: Intrepid Value was ranked first of 400 funds since its release in

2003

Page 23: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Top JPM BF Funds Updated Status

Page 24: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

QUESTIONSQUESTIONS

Page 25: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Back up

Page 26: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Loss Aversion: Pop Quiz

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

A friend wants to make a bet with you. If accept the bet you will have a 50% chance of losing $10,000 and a 50% chance of winning $_______.

How much would you want to have a chance of winning before you would take the bet?

Please right down your number

Page 27: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

Loss Aversion: The Disproportion of Gain & Loss

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Most people want to gain between 2 and 2.5 times as much as they put at risk. So most people will want a chance to win $20,000 before they will play.

Practical Example: Between 1926 and 2000

Stocks returned 8% (real) Bonds returned 2% (real)

The answer is loss aversion: The less frequently you evaluate stocks, the less risky they appear. People tend to evaluate stocks as if they had a short time horizon.

Question: Why would anyone

invest in bonds?

Page 28: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Anticipation of gain (greed) is more satisfying than the actual gain Pain of loss has a larger emotional impact than the pleasure of

gain Investors lose confidence in markets due to the media response,

herding, and anchoring effects Excessive conservatism and aversion to risk is exacerbated by

narrow framing, mental accounting and short time horizons Investor overconfidence, optimism and minimization of

uncertainties create inflated egos Investors often repeat predictable, destructive behaviors and

don’t learn from past mistakes

Bottom line: These behaviors and reacting to ‘recency’ events leads to lower overall returns over the long-term.

Behavioral Finance: Key points

Page 29: Behavioral Finance at JP Morgan Managerial Finance Presentation Presented by Hussein Elgarhy & Fouad Ellaithy Supervised by Prof. Dr. Mustafa Eldewany.

© Hussein Elgarhy and Fouad Ellaithy, MsM-RITI-Cairo Outreach Program, 2010.

Recognize that behavioral issues affect us all—including financial advisors, institutional money managers, and individual investors

Do a self-assessment to determine what behaviors you’ve exhibited and how it may impact the advice you provide clients or the advice your clients have clients—or received from other advisors

Challenge the financial advisors you work with—see with see if their advice and recommendations are influenced by latent behavioral biases

Conclusion


Recommended