People tend to do things that make them feel good, and avoid things that make them feel bad. Intuitive, as the revelations of psychology often are, this nugget has found new application in explaining some of the seemingly irrational behaviour of individual investors. STEPHEN SHORE reports.
Nicholas Barberis, professor of finance at the Yale School of Management, and his colleague Wei Xiong at Princeton, suggest in their new paper, ‘Realisation Utility’, that there is a burst of positive or negative feeling that follows from each investment transaction. The researchers claim that this emotion is a direct influence on people’s behaviour, and by accounting for it in mathematical models, they can help explain a number of quandaries, such as why there is greater turnover in rising markets, and why individual investors tend to underperform benchmarks. Barberis presented his research last month at the Paul Woolley Centre for Capital Market Dysfunctionality Conference at the University of Technology, Sydney.