This article from the Wall Street Journal provides an interesting follow-up to yesterday’s behavioral finance discussion. “Information avoidance” represents a particularly strong (and potentially deadly) form of confirmation bias!
This (year-old) WSJ article is authored by Professor Meir Statman, the Glenn Klimek Professor of Finance at Santa Clara University. Professor Statman’s research focuses on behavioral finance, which is a very important topic in decision theory that I plan to cover during next Tuesday’s meeting of Finance 4335.
The questions financial advisers ask clients to get at the answer actually measure something completely different—often leading to misguided investment strategies.
Four years ago, The Economist published a particularly interesting article about the determinants of risk aversion, entitled “Risk off: Why some people are more cautious with their finances than others”. Here are some key takeaways from this article:
- Economists have long known that people are risk-averse, yet the willingness to run risks varies enormously among individuals and over time.
- Genetics explains a third of the difference in risk-taking; e.g., a Swedish study of twins finds that identical twins had “… a closer propensity to invest in shares” than fraternal ones.
- Upbringing, environment, and experience also matter; e.g., “…the educated and the rich are more daring financially. So are men, but apparently not for genetic reasons”.
- People’s financial history has a strong impact on their taste for risk; e.g., “… people who experienced high (low) returns on the stock market earlier in life were, years later, likelier to report a higher (lower) tolerance for risk, to own (not own) shares and to invest a bigger (smaller) slice of their assets in shares.”
- “Exposure to economic turmoil appears to dampen people’s appetite for risk irrespective of their personal financial losses.” Furthermore, a low tolerance for risk is linked to past emotional trauma.
The generation now entering the workforce is sober, industrious and driven by money. They are also socially awkward and timid about taking the reins.
Following up on my previous blog posting entitled “The world has not learned the lessons of the financial crisis”, today’s “Heard on the Street” column in the Wall Street Journal entitled “What Will Trigger the Next Crisis?” is required reading! Both articles are motivated by the fact that we are now ten years out from the bankruptcy (on September 15, 2008) of Lehman Brothers. Many commentators mark this day as the seminal event for what is now commonly referred to as the so-called “Global Financial Crisis of 2008” – widely considered to have been the worst financial crisis since the Great Depression of the 1930s.
In the video linked below, the Insurance Information Institute imagines what the world would be like without insurance. Spoiler alert: such a world would be a dystopian nightmare – it would be unsafe, much poorer, and significantly less innovative and resilient.
One year ago this coming Sunday, the article cited below was the cover story for the 9/2/17 issue of The Economist. The points raised by this article (regarding the “moral hazard” associated with mispriced/subsidized insurance coupled with misguided NFIP claims policies) are (unfortunately) as valid today as they were back then.
Quoting from this article,
“Underpricing (of flood insurance) encourages the building of new houses and discourages existing owners from renovating or moving out. According to the Federal Emergency Management Agency, houses that repeatedly flood account for 1% of NFIP’s properties but 25-30% of its claims. Five states, Texas among them, have more than 10,000 such households and, nationwide, their number has been going up by around 5,000 each year. Insurance is meant to provide a signal about risk; in this case, it stifles it.”
Financial historian John Stuart Gordon’s essay in today’s Wall Street Journal provides some particularly fascinating examples of rare events from the 19th, 20th, and 21st centuries!