Why Progress in Behavioral Finance is Important for the Future (2024)

Behavioral finance in the financial markets today has burgeoned to the point in which there is an emerging third category for phd candidates in finance. This disparate concentration on obtaining an established career, in either the area of industry or academia, will bring a plethora of discoveries for the future of finance. It was only less than 10 years ago that the only two concentrations for phd candidates were either Corporate Finance or Asset Pricing. Due to several discoveries and breakthroughs in disproving the Efficient Market Hypothesis (EMH), however, behavioral finance is becoming more and more apprised as there is a growing demand with the financial challenge and reward to become better, more patient, more agile, and more precise, in contrast to trends and seemingly predictable earning forecasts. Behavioral finance has meaning in the financial markets and is imperative to study, regardless of an investor’s investment philosophy.

One of the most important reasons as to why a career in behavioral finance will always be needed in the future is because of the fact that there will always be trends in society and that no one wants to be average. No matter which sector, industry, or team, there is always the conflict to become at least slightly better than the average of those among us. This doesn’t mean that everyone wants to always be better than average all of the time. It does mean, though, that someone will usually and eventually want just a little more or a little bit better than the rest of the group. As humans, we are hard-wired to seek a competitive advantage and the two spectrums of greed and fear are action signals to guide human behavior to grow and to evolve in order to maximize our survival rate and our standard of living. The discoveries of behavioral finance save us tremendous time to reinvent the wheel of finance theory and/or one’s investment philosophy and to make inferences based on partial anticipation. This saves teams and investment firms who are in competition time, energy, and resources while also being able to minimize the meetings and strategic focus and to eschew wasted time lamenting over what the crowd, regarding a sector of the financial markets, are looking to buy, sell, wait-out, or short.

The opportunities that behavioral finance brings to a hedge fund, or an investment management firm is to be able to craft a compelling and convincing story to attract clients who are in mid-range or affluent households and who have stable careers, but who lack the time, passion, and or energy to create their own portfolios to invest themselves. Investment strategies that are well-defined and clearly crafted for clients to understand and to pinpoint strategies and tactics by a research and trading team though a compelling story still arguably are more convincing than that of an individual investor who earned one year and beat the market, but who is holding a black box of algorithms and just telling investors who join in. The situation we are in, economically speaking, is vastly different from that of 2013, where financial securities such as Nike (NKE) earned a spike of a 30% increase after their 2nd Quarterly Earnings Call. With The current inflation gradually decreasing, but pricing is remaining robustly high. Now add-in the trends in which cryptocurrencies came and went, along with the Wall Street Bets to “hold the line” regarding GameStop (GME), followed by SBF and Kathy Wood’s clients trying to just break-even and it’s no wonder that prospects would instantly shy away or even just keep their assets as cash, regardless of returning inflation.

In all the reasons that behavioral finance will play an important role in the financial markets, perhaps the best reason is to help the financial markets as a whole find some level of trust and hope with a long-term focus in the markets. The reality is, the individuals who are holding the financial securities, those who are not cashing out a tremendous amount of assets day-by-day are those who are maintaining the market from wild swings. Fortuitously, due to regulations by the SEC and FINRA, there will be a market shutdown due to unpredicted large drops in the market. How does behavioral finance play a role in relatively minimizing these huge drops? Investment managers obviously don’t want a ubiquitous market shutdown if they were to try to short a particular financial security. The reason is that the market shutdown would allow a large firm that has experienced a large decrease in the price of their financial security to try to urgently seek out a financial activist, like George Soros or Will Ackman. These activists possess not just tremendous assets and positive cash flow to invest and prop-up a financial security, but they can also tap into their networks and ask the most influential leaders in their network to also spread the word to try to either turn the firm into their favor, or to look to short the financial security as well. However, due to the variety of investment philosophies and different timing strategies these investment firms and individuals have, the market will adjust to the sum of the shares’ perception are in favor of buying or selling. If there are more buyers, then the financial security will increase. If there are more sellers, then the price of the financial security will decrease further.

To recap, behavioral finance holds a very potent and promising position in the world of both industry and academia. Someone in a particular organization or team wants to be at least slightly better than average, and thus, the upswings and downswings of the financial markets will always occur, which are over-layered by a combination of speculation, hedging, and arbitrage strategies. As there have been several negative trends that possessed the verisimilar promise that a positive trend, such as cryptocurrency kitties, DOGE, Kathy Wood’s investment philosophy, or even Wall Street Bets were here to stay, these events unfolded into exacerbating and financially stressful times, especially for those in the middle and affluent households. As these negatives events that possess the semblance of the pioneer spirit and one that hold the invitation to a brand-new promising frontier, these trends will always come and go, which allow hedge funds and investment management firms to make inferences and to capitalize in the long-term. Perhaps the most important reason to value behavioral finance now is that, whether a positive or negative event occurs in the short-term, the ability to apply inferences to the past, present, and future with financial models gives investors, in one sector, somewhere, hope that the long-term rewards will manifest and be rewarded.