Investor Behavior: The Psychology of Financial Planning and Investing

CHAPTER 27

Trading and Investment Strategies in Behavioral Finance

John M. Longo, CFA

Clinical Professor of Finance and Economics, Rutgers Business School—Newark and New Brunswick, and Chief Investment Officer, The MDE Group, Inc.

INTRODUCTION

Behavioral finance was once on the fringe of academic finance, but now it clearly has wide acceptance with investment professionals and individual investors. Although behavioral finance is not a new concept, it has garnered increasing attention and respect in recent years. Keynes (1936) understood the role of investor psychology in markets when he indicated that “animal spirits” drove prices. According to Benjamin Graham (1973, p. xv), the father of value investing, “The investor's chief problem—and even his worst enemy—is likely to be himself.” The ultimate imprimatur occurred in 2002, when Daniel Kahneman and Vernon Smith received the Nobel Memorial Prize in Economic Sciences for their work in behavioral finance and experimental economics. Thaler (1999), a leading scholar in the field, predicts that the term “behavioral finance” will be a redundant term, noting, “What other kind of finance is there?”

This chapter focuses on questions related to the practical analysis and understanding of behavioral finance. For example, what investment strategies associated with behavioral finance have been at least partially successful? What excess returns have these strategies historically generated? Are these strategies likely to continue to add value? ...