Saturday, 17 August 2013

New information is interpreted, and not all of that interpretation is rational. (Behavioral Finance)

Psychological research in behavioural finance dispute the idea that investors act as dispassionate calculating machines.

It turns out that like everyone else, investors respond to events in the world with certain powerful biases.  

New information is interpreted, not simply digested, and not all of that interpretation is rational.

One powerful set of biases tends to give more significance to the most recent news, good or bad, than is actually warranted.  The stocks of companies that report high rates of growth are driven to extremes, as are stocks of companies that disappoint.  (Recency bias).

These findings about excessive reactions confirm a belief that value investors have held since Graham:  Over the long run, performance of both companies and share prices generally reverts to a mean.

"Many shall be restored that now are fallen and many shall fall that now are in honor."

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