Everything takes time. The mainstream financial world has always been deliberate (read that as slow) to adopt new investment paradigms into practice. While academia churns out a number of new theories, models, processes, and measures seemingly every day for just about every aspect of the financial markets, it can often take years if not decades to become accepted into everyday use. Consider for example Modern Portfolio Theory which, at its core, is about the risk management benefits of putting different types of assets together into a mix. The concept had its beginnings in the 1950s, but it was not widely implemented until decades later and this was for an idea as intuitive as “don’t put all of your eggs in one basket.” The same is true for behavioral finance. Pioneered by Amos Tversky and Daniel Kahneman, these concepts started to relax the basic assumption in classical economics that all people are “rational” (i.e. a person’s decisions are optimal to maximize benefit). While that is nice for a theory, we all know not every human decision in the real world is rational.
The first concepts of behavioral economics were developed in the late 1960s in parallel with progress in the field of cognitive psychology. Various “discoveries” were made over the subsequent years. One of the better known ideas put forth by Tversky and Kahneman is “loss aversion” which they discussed in a published paper in 1984. Basically, a person feels more pain from a loss than they do pleasure from a gain (it is often cited a person feels a loss 2x as powerfully as a gain). Therefore, the logic continues that a person will make decisions to avoid the risk of loss (or a perceived loss). This plays out in many ways but acutely in the financial markets. Fear and greed, it has been said for many years, is what drives day to day market action. Only decades later, again, are the precepts of this approach to economics being incorporated into investing. It took until 2002 for Kahneman to receive a Nobel Prize for the work (Tversky had passed and the award is not given posthumously). However, this week there is a new study released which suggests that maybe people are not risk averse at all. Hmmm. Have people changed? While not as academically rigorous as a peer-reviewed study, a quick glance around would suggest not. I guess academia can be subject to “noise” just like the markets in the short term. Everything takes time.