Chapter 3Risk, This Time It's Personal

Dr. Daniel Crosby

Only those who will risk going too far can possibly find out how far one can go.

—T.S. Eliot

While there are myriad differences between EMH and behavioral approaches to financial theory, nowhere are these differences more pronounced than in how they each define and think about risk. If asked to speak to the heart of the difference, this is at the core: behavioral approaches are embodied, whereas efficient market approaches are disembodied. Behavioral approaches attempt (with varying degrees of success) to couch theory in the imperfect minds and behaviors of those who play it out. In contrast, efficient market approaches opt for “dream world” scenarios wherein the messiness of behavior is removed in favor of parsimonious modeling.

As Dr. Greg B. Davies, Managing Director, Head of Behavioral and Quantitative Investment Philosophy, Barclays Wealth, says about the phenomenon of EMH and its associated approaches, “These shortcuts made it much easier to build an elegant theory. Convenience and parsimony in presentation became more valued than an accurate representation of reality” (Davies and De Servigny 2012). He goes on to explain the uncertain times in which we find ourselves in a post-EMH world by stating, “Thus we now find ourselves in a very interesting situation where the plans of the financial market architects largely have been followed, the infrastructure exists, but the foundations on which these plans were grounded ...

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