Applying Behavioral Finance to Investments: The Existence and Importance of 'Investment Tribes'

20 Pages Posted: 20 Aug 2019

See all articles by Sid Muralidhar

Sid Muralidhar

Risktyle; The Virginia Tech Foundation

Arun Muralidhar

AlphaEngine Global Investment Solutions; George Washington University

Date Written: August 14, 2019

Abstract

Investment organizations are complex to understand because decisions are the aggregation of multiple individuals who influence the process. This applies to organizations that apply both quantitative and qualitative investment approaches because the first step in a quantitative approach is still a qualitative statement of the investment hypothesis that is then formalized by the models. Increasingly, finance practice is starting to incorporate behavioral finance insights and recognize that individuals are not “rational utility maximizers”, but rather complex psychological beings that can exhibit non-traditional behaviors. Kahneman-Tversky (KT) introduced this notion of individuals being “humans” and not “econs” but made broad generalizations about behaviorally affected decisions (BADs) and did not provide a methodology to examine individual biases. A technique has been proposed to use KT’s questions to provide individual behavioral diagnostics and previous research demonstrated dramatic differences within and across groups based on age, gender and financial literacy, especially for gambles based on prospective gains and losses. This paper is a case study of a single asset management company that uses a mix of quantitative and qualitative investment techniques, driven by five decision makers with equally weighted votes in the final decision. In addition to demonstrating that each individual in the investment committee is unique and providing individual diagnostics that show that age, gender and education need not lead to a particular behavior, this paper highlights the fact that organizations have “investment tribes”; namely, that there are groups of individuals who appear to exhibit similar risk tendencies for gambles involving gains or losses. These tribes can influence and impact decision-making. Quantifying and making transparent the existence of these tribes could improve decision-making. This case study can be helpful for investment firms allowing them to become aware of potential biases, and also for asset owners that delegate decisions to third parties, as it allows them to understand how the investment firms they delegate to might behave when they experience drawdowns.

Keywords: Behavioral Finance; Investment Tribes; Risktyle, Consistency Smile, Behavioral Diagnostic; Behavioral Bias; Loss Aversion; Risk Seeking; Investment Decision-Making

JEL Classification: G11, G40, G41

Suggested Citation

Muralidhar, Sid and Muralidhar, Arun, Applying Behavioral Finance to Investments: The Existence and Importance of 'Investment Tribes' (August 14, 2019). Available at SSRN: https://ssrn.com/abstract=3437116 or http://dx.doi.org/10.2139/ssrn.3437116

Sid Muralidhar (Contact Author)

Risktyle ( email )

9603 Georgetown Pike
Great Falls, VA VA 22066
United States
5716239272 (Phone)
22066 (Fax)

HOME PAGE: http://risktyle.org

The Virginia Tech Foundation ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

Arun Muralidhar

AlphaEngine Global Investment Solutions ( email )

Great Falls, VA
United States

HOME PAGE: http://www.mcubeit.com

George Washington University ( email )

2121 I Street NW
Washington, DC 20052
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
172
Abstract Views
694
rank
194,048
PlumX Metrics