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MIS 4500 (31)
Lecture 18

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Management Info. Systems
MIS 4500
Pourang Irani

Lecture 18: Goals-Based Investing: Integrating Traditional and Behavioral Finance Define portfolio efficiency in terms of client goals instead of relying on traditional measures of return and standard deviation, then create strategies matched to each goal Investor goals: 1. lifestyle needs, 2. wealth transfers, 3. charitable gifts Risk Measurement:  traditionally standard deviation, etc. i. however, return distributions are non-normal: skewed, excess kurtosis and heteroskedastic ii. doesn’t describe risk in terms of clear outcomes / the way investors experience risk  loss aversion: investors are not risk averse, but loss averse i. risk measures should address : likelihood that loss will occur, severity of loss or both (say probability of loss and downside deviation)  risk measures are usually annualized or some short period, failing to convey risk over multiple periods i. consider troughs occurring at end date Risk Profiling:  Decision Framing: slight differences in the way that questions are posed lead to very different answers about people’s preferences  Mental Accounting: multiple attitudes about risk; manage risk on goal-by-goal basis; maintaining separate investment accounts, either mentally or in practice, and making decisions differently depending on the nature of the account. Managing Behavioral Biases:  loss aversion: develop strategies to manage losses  mental accounting: develop strategies that can be aligned w/ investors’ separate goals and accounts  biases should be controlled rather than accommodated o Overconfidence: overestimate abilities; take risks w/o commensurate returns; overtrade o Hindsight bias: believe that predicted event when didn’t o Overreaction: to overinterpret patterns that are coincidental and unlikely to persist o Belief perseverance: unlikely to change opinions even when new info becomes available o Regret avoidance: tendency to avoid actions that could create discomfort over prior decisions, even though those actions may be in the individual’s best interest  hold losers too long (disposition effect) o recommendations:  goals and preferences should be defined as clearly as possible and supported through risk management, using measures such as probability of breaching goal and potenti
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