Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing

Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing (Hardcover) by Hersh Shefrin

When I worked as Research Assistant under Mr. Edward Kong of EK Investment, I found Edward read a lot of academic journals. I was curious about this and asked him did he find academic research too "theoretical". Edward explained that in investment decision making, knowledge always provide edges. Advance finance research provides new insight on old subject. Although academic research always base on various assumptions that seem unrealistic, however this does not mean we cannot benefit from academic research.

He used efficient market theory as an example. Obviously, the market is not as efficient as the theory suggested, hence, he work backward – If the market is not efficient, what’s wrong with the assumption.

Assumption one of EMT, information is free and equally available, working backward, that’s mean investor with better information can get better results. Assumption two of EMT, given the same information, everyone draws the same conclusion, that means better interpretation and insight on data / event enable investor to earn abnormal results.

In 1996/9, I found Edward spend several days reading a “pillow-like” academic paper. It was research on psychology (yes, psychology, not “psychology on finance” or “behavioral finance”). The book was 1.5 inch thick and full of mathematic formula.

“Well, what the hell! Psychology?” I thought. By that time, I was too busy to learn the basic financial analysis skill. Reading stuff like this was far too advanced for me. But from then on, I have a feeling “psychology” and “finance” have relationship somehow.

At 2000, I found the book: “Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing” by Hersh Shefrin. Priced at $HK439, but after I finished a chapter, I bought it without any hesitation.

The book explain all kind of psychology research findings that are related to “investing”, “gambling” and “risk taking” such as “Prospect Theory”, “Heuristic-Driven Bias”, “Frame Dependence”, “Representative-ness”, “Anchoring” etc.

Shefrin explain all the key concepts in story-telling style. No mathematic formula, no tons of data, just experiments after experiment, examples after examples.

Almost all the findings were based on psychological experiments under controlled environment. In most of the cases, you can test yourselves with those experiments (in your mind) before he show you the result. A really joyful reading experience, I found.

Over the last 25 years of research, psychologists have discovered two important facts. (1) As psychologist Lola Lopes pointed out, the primary emotions that determine risk-taking behaviour are not greed and fear, but HOPE and FEAR. (2) Although to err is human, financial practitioners of all types make the same mistakes repeatedly.

The cause of these errors is documented in an important collection edited by psychologist Daniel Kahneman (who was the winner of 2002 Nobel Prize in Economics for his work in “Prospect Theory”, despite Kahneman claims to have never taken a single economics course) and other researchers.

The “Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing” provides a painless way to digest the treasures of 25 years of psychology research on human risk-taking behaviour.