Behavioral Finance at JP Morgan Case Study
Psychological and Social Biasness
From the case study, there are several psychological and social biases that the investors are likely to show. The JP Morgan case depicts two central behavioral psychology, including overconfidence and loss of aversion. Overconfidence occurs when some investors overestimate the accuracy of the decision they have made in their respective investments. The main challenge is that it can result in under diversification in the portfolio. An investment will only be made on a small number of stocks due to the assumption that they will have the informational advantage (Kumar, 2015c). Based on the outcomes of the survey drivers, only 80% have a strong belief that there are better than an average driver, which in most instances is not possible.
Loss aversion is defined as the tendency of an individual to seek pride and deviate from any regrets that will arise from their investment decisions. In other terms, it is referred to as the disposition effect. The majority of the investors in such a situation are more likely to sell their winners and less of the losers. More preference is given to the uncertain loss than the inevitable loss, but there is a preference over inevitable gain that the doubtful advantage, which is most situation is counterintuitive. There are three main reasons investors will behave in such a manner (Baker and Sesia, 2007). They include a high expectation that the downtrend will reverse the course, losing will be too painful, and the fear of not being in a position boosts the wins of the various friends and family members.
Additionally, recency and anchoring are the two social biasness that the investors experience from the JP Morgan Case Study. Recency occurs when individuals develop the tendency to overemphasize the recent returns of an organization while they are taking part in their investment decisions. The biasness can influence the macro and micro-operation of the market (Baker and Sesia, 2007). If a person makes an investment decision based on a company’s current earnings, then the recency effect will take place. It will not indicate that the investment that has been made is good because things are likely to change. Issues of inflation might arise, and intron the investment decision will be impacted either positively or negatively. Therefore, several other components need to be put into consideration during an investment decision.
Anchoring occurs when the investors are fixated on a piece of information or data that they think will help them make the investment decision that will result in higher yields. In connection with the financial analyst, they become anchored to the forecasting they have been making, hoping the results will be on how they have predicted. There is less reaction that will be accorded any new information even if it will be relevant in the decision-making process. There will be too much information on the nature of investment that the investors decide to cling to and makes a biased decision.
Elimination of the Biasness
The biasness that the investors are likely to encounter will be very hard to eliminate, but there is a need to have measures that will control them. Self-awareness is the first strategy that can be used in controlling biases. The focus is on making people realize all the external and internal forces that have a high chance of affecting their decision-making capabilities. There is a need to deviate from making a decision that is based on emotions. The Intrepid Funds that JP Morgan has created have been done based on a framework that is contrarian. The main idea was to have the fund accomplish tasks that are opposite to that of everyone else. The approach has been effective and efficient in ensuring that the Intrepid Fund is operational and successful. It was possible to accomplish the task by being aware of some typical behavior biases (Baker and Sesia, 2007). Two main investment philosophies were applicable, including contributing to the value stocks, which have been effective in voiding the overconfidence bias and taking advantage of the monumental stocks that dealt with the loss aversion bias.
In addition to the anchoring and recency, other steps can be taken to avoid biases. It will start with having enough information about the tendencies and then taking the most appropriate action to assist the management. Recency can be managed through less attention given to the recent investment returns of an organization. Still, a key consideration should be on the overall level of performance for the whole company in general (Kumar, 2015c). Lastly, anchoring can be managed by ensuring that an individual is open-minded and perceives any data or information as if it is the first-ever encounter.
Exploitable Investment Opportunities
Yes, Complin and the other team members believe that the irrational behavior that resulted in market anomalies can be taken advantage of through a trading system. There were only two market abnormalities that have been witnessed from 1951 to 2005. The first one is the cheap stocks that lead to the outsmarting of the expensive stock through valuing stocks. More so, the outcomes of the investigation by the organization indicated that in the previous year, an investment was made on the best performers and the average annual return was 15.2%. From the study carried out by JP Morgan, the outcomes indicate that the value of stocks returned to an average of 15.8% annually (Baker and Sesia, 2007). However, the value of the more expensive stocks was 2.8%. The other anomaly that was encountered was on specific stocks that had recently performed well than those whose recent returns were much more significant through the process of monument investment.
In comparison, the outcomes of the worst performers were 3.4% (Baker and Sesia, 2007). There is no rational explanation that can be accorded the two anomalies, but through behavioral biases, it will be possible to decode the issue. Complin and Silvio were in charge of the intrepid portfolio Funds. They believed in the two common biases, namely overconfidence and loss aversion, as the leading cause of the value and monument abnormalities.
Opportunities Expected to Survive
There are no criteria that can be used to determine why or how long they will survive. However, they are not a part of who we are, and it will take several years for the brain to be able to shift into the rationality and reality of the situation, which may not be possible. But a key agreement is that humans have been depicting the biasness for centuries. For example, in 1637, the Dutch Tulip Mania created the creation, where the cost of a bulb at its peak level was $76,000, but the actual intrinsic value for the commodity was close to zero (Kumar, 2015c). There is a distortional view of how worth the costs of the products, which is a bias that has been in existence for centuries, and at the moment, it is being experienced in the cryptocurrency industry. Therefore, there is a high expectation that the investment opportunities will survive in situations with no end in insight.
Why don’t Investors Learn or Eliminate the Biases?
Investors can’t learn or eliminate their biases if they are not aware that they are taking place. Behavioral biases cannot be eliminated, and instead, people need to be mindful of their existence. A person can either be self-aware or be told that they are exhibiting some sights of the biases (Kumar, 2015c). In the JP Morgan assets management division, those in charge were taught how that could handle clients that behave in a given manner. Conclusion: there is a clear depiction that the bias cannot be eliminated but can be easily managed in various situations. It will be possible to achieve the goal through a continuous and repeatable process of educating the investors.
Equity Analyst or Mitigation Assets Pricing
Equity analyst is vital in the amplification of miss-pricing. From a study carried out by JP Morgan, the outcomes indicate that most of the analysts are victims of “in-group bias.” However, the analysts are also humans and can easily be carried away with the issues of biases. Therefore, there is an expectation among the analysts that the CEO of various organizations will have the same demographics that will make them perform better and give the buy rates (Kumar, 2015c). But in situations where the demographic is different, analysts expect that the company’s level of performance will not be good, resulting in a surprise in cases where the outcomes reports are positive.
References
Baker, M. P., & Sesia, A. (2007). Case study: Behavioral finance at JP Morgan (HBS Case Study No. 9-207-084). Retrieved from Harvard Business publishing https://cb.hbsp.harvard.edu/cbmp/access/37227892
Kumar, A. (2015c). Lecture notes 3 [PowerPoint slides].
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