Behavioural Finance for Private Banking

260 Pages·2.715 MB·English

by  Thorsten Hens, Kremena Bachmann(auth.)

Behavioural Finance for Private Banking
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Behavioural Finance for Private Banking
Thorsten Hens
and
Kremena Bachmann
A John Wiley and Sons, Ltd, Publication
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LibraryofCongressCataloging-in-PublicationData
Hens,Thorsten.
Behaviouralfinanceforprivatebanking/ThorstenHens,KremenaBachmann.
p. cm.—(TheWileyfinanceseries)
Includesbibliographicalreferencesandindex.
ISBN978-0-470-77999-6(cloth)
1. Privatebanks. 2. Investments—Psychologicalaspects. 3. Finance—Psychological
aspects. 4. Banksandbanking—Customerservices. 5. Wealth—Management. I. Bachmann,
Kremena. II. Title. III. Title:Behavioralfinanceforprivatebanking.
HG1978.H462008
332.1(cid:2)230688—dc22
2008038617
AcataloguerecordforthisbookisavailablefromtheBritishLibrary
ISBN978-0-470-77999-6
Typesetin10/12ptTimesbyIntegraSoftwareServicesPvt.Ltd,Pondicherry,India
PrintedandboundinGreatBritainbyAntonyRowe
ToBritta,JeromeandAnnabelle,
aswellastoChristophandVivien.
Contents
ListofFigures ix
ListofTables xiii
Notation xv
Preface xxi
1 Introduction 1
1.1 Theprivatebankingbusiness 1
1.2 Currentchallengesinprivatebanking 3
1.3 Improvingservicequalitywithbehaviouralfinance 6
1.4 Conclusion 9
2 DecisionTheory 11
2.1 Introduction 12
2.2 Mean-varianceanalysis 14
2.3 Expectedutilitytheory 22
2.4 Prospecttheory 35
2.5 Prospecttheoryandtheoptimalassetallocation 50
2.6 Acriticalviewonmean-variancetheory 59
2.7 Acriticalviewonexpectedutilityaxioms 63
2.8 Comparisonofexpectedutility,prospecttheory,and
mean-varianceanalysis 64
2.9 Conclusion 65
3 BehaviouralBiases 67
3.1 Informationselectionbiases 68
3.2 Informationprocessingbiases 70
3.3 Decisionbiases 82
3.4 Decisionevaluationbiases 87
3.5 Biasesinintertemporaldecisions 88
3.6 Behaviouralbiasesandspeculativebubbles 91
3.7 Culturaldifferencesinthebehaviouralbiases 95
viii Contents
4 RiskProfiling 105
4.1 Dealingwithbehaviouralbiases 105
4.2 Theriskprofileranditsbenefits 106
4.3 Designingariskprofiler:Somegeneralconsiderations 108
4.4 Implementedriskprofilers:CasestudyoftheformerBankLeu 109
4.5 Ariskprofilerbasedonthemean-varianceanalysis 114
4.6 Integratingbehaviouralfinanceintheriskprofiler 117
4.7 Casestudy:Comparingriskprofiles 127
4.8 Conclusion 134
5 ProductDesign 135
5.1 Casestudy:“LadderPop’’ 136
5.2 Casestudy:“DAXSparbuch’’ 143
5.3 Optimalproductdesign 149
5.4 Conclusion 155
6 DynamicAssetAllocation 157
6.1 Theoptimaltacticalassetallocation 158
6.2 Theoptimalstrategicassetallocation 171
6.3 Conclusion 184
7 LifeCyclePlanning 187
7.1 Casestudy:WidowKassel 187
7.2 Maindecisionsovertime 189
7.3 Consumptionsmoothing 189
7.4 Thelifecyclehypothesis 190
7.5 Thebehaviourallifecyclehypothesis 192
7.6 Thelifecycleassetallocationproblem 194
7.7 Thelifecycleassetallocationofanexpectedutilitymaximizer 195
7.8 Thelifecycleassetallocationofabehaviouralinvestor 198
7.9 Lifecyclefunds 202
7.10 Conclusion 206
8 StructuredWealthManagementProcess 207
8.1 Thebenefitsofastructuredwealthmanagementprocess 209
8.2 Problemsimplementingastructuredwealthmanagementprocess 210
8.3 Impactofthenewprocessonconflictsofinterests 210
8.4 Learningby“cycling’’throughtheprocess 211
8.5 Casestudy:CreditSuisse 211
8.6 Mentalaccountinginthewealthmanagementprocess 217
8.7 Conclusions 226
9 ConclusionandOutlook 229
9.1 Recapitulationofthemainachievements 229
9.2 Outlookoffurtherdevelopments 229
References 231
Index 237
List of Figures
1.1 EfficiencyandprofitabilityoflocalandforeignbanksinSwitzerland 2
1.2 ROEweightedbythecapitalizationlevelofdifferentcountries 3
1.3 Differentiationdrivers 5
1.4 Segmentationcriteria 6
2.1 Thelotterygivenbythereturnsofafundofhedgefunds 13
2.2 Mean-variancerepresentationoftheriskpremium 16
2.3 Theefficientfrontier 16
2.4 Riskaversionandriskpremium 17
2.5 Selectingtheoptimalportfolio 17
2.6 Two-fund-separation 19
2.7 Illustrationofthecertaintyequivalent,riskpremium,andriskaversion 29
2.8 Jensen’sinequality 30
2.9 Thevaluefunction 39
2.10 Theprobabilityweightingfunction 42
2.11 Returnofhedgefundsastheyareandasseenbyaprospecttheoryinvestor 45
2.12 Returnprobabilities 46
2.13 Risktakingconditions 49
2.14 Mean-variancepreferences,basedonthepiecewisepowervaluefunctionof
KahnemanandTversky 51
2.15 Mean-standarddeviationdiagramwithPT-indifferencecurvesbasedonthe
piecewiseexponentialvaluefunction 51
2.16 Reward-riskperspectiveontheprospecttheory 55
2.17 Cumulativegrossreturns(1993–2006) 56
2.18 Assetreturnsinamean-variancediagram 56
2.19 Assetreturnsinanaverage-gain-lossdiagram 57
2.20 Mean-variancetangentialportfolio 57
2.21 Optimalassetallocationofabehaviouralinvestorwithβ=2 58
2.22 Optimalassetallocationofabehaviouralinvestorwithβ=5 58
2.23 Optimalassetallocationofabehaviouralinvestorwithβ=10 58
2.24 Twoquitedifferentstructuredproductswiththesamemeanandvariance 59
2.25 Themean-varianceparadox 60
2.26 ThetangentportfoliowithoutSPI+ 61
2.27 ThetangentportfoliowithSPI+ 61
2.28 OptimalassetallocationofabehaviouralinvestorwithoutSPI+ 61
x ListofFigures
2.29 OptimalassetallocationofabehaviouralinvestorwithSPI+ 62
2.30 TheEllsbergparadox 64
2.31 Similaritiesanddifferencesofexpectedutility,prospecttheory,and
mean-variance 65
3.1 Atypicaldecision-makingprocess 68
3.2 Illustrationofconditionalprobability 71
3.3 Experimentalresultsonthegambler’sfallacy 73
3.4 PerformanceofLGT-GSTfundanditsbenchmark 74
3.5 IdealgrowthstockpurchaseaccordingtoFullerandThalerAsset
Management 77
3.6 Theoverconfidenceeffectinthecaseofforecasting 79
3.7 Hazardoustrading 80
3.8 Averagereturnperinformationlevel 80
3.9 Exploitingthefavouritelong-shotbias 82
3.10 Portfoliopyramid 83
3.11 Dispositioneffect 84
3.12 EquityportfolioweightsofU.S.,JapaneseandBritishinvestors(Basedon
FrenchandPoterba(1991)) 85
3.13 Investor’spayoffovertime 91
3.14 CulturaldifferencesaccordingtoHofstede’s“Uncertainty
AvoidanceIndex’’ 95
3.15 Valuefunctionsofstudentsindifferentcountriesbasedontheresultsof
Bontempoetal.(1997) 96
3.16 Valuefunctionsofstudentsindifferentcountriesbasedontheresultsof
WeberandHsee(1998) 97
3.17 Inflationrateversusdegreeofpatienceinseveralcountries 99
3.18 Incomepercapitaversusdegreeofpatienceinseveralcountries 99
3.19 Individualismversuslossaversionindex(theta) 100
3.20 Trendchasingandindividualismaroundtheworld 101
3.21 Ambiguityaversionandtheequitypremium 104
4.1 DifferentadvicefromvariousbanksaccordingtoStocksmagazine
41–42,2003 107
4.2 AnexperimentallaboratoryattheUniversityofZurich 109
4.3 Riskabilityinthemean-varianceanalysis 116
4.4 Mean-varianceanalysiswithriskability 116
4.5 Heterogeneityintheindividuals’riskandlossaversionassessedinastudy
atZKB 118
4.6 Heterogeneityintheindividuals’riskaversionovergainsα+andlossesα− 118
4.7 Heterogeneityintheindividuals’perceptionofprobabilities 119
4.8 Timediversification:Thelongertheinvestmenthorizon,thebetter
thereturn-riskratio 123
4.9 Probabilityforbondsbeatingstocksforportfolioswithdifferenttime
horizons 124
4.10 Optimalassetallocationoverdifferenttimehorizons 124
4.11 InvestmentadviceoftheformerBankLeu 130
4.12 OptimalassetallocationofChristineKuhnaccordingtoBhFS 133
4.13 Client’sclassificationbasedonpredefinedriskprofiles 133
ListofFigures xi
5.1 Optimalpayofffromtheperspectiveofbehaviouralinvestors 136
5.2 PayoffoftheLadderPopatmaturity 138
5.3 SMIandLadderPopprices(indexed)from15.01.2002to12.12.2006 138
5.4 Twowaysofachieving8.1%returnaftertwoyears:Investingat4%each
yearorchangingto10%afterthefirstyear 139
5.5 Scenariossetup 140
5.6 PayoffDAXSparbuchpermonth 145
5.7 Payoffofabarrier-likestructuredproduct 149
5.8 Optimalstructured-productofaCRRAinvestorwithα=0.8 151
5.9 Optimalstructuredproductforamean-varianceinvestor 152
5.10 Optimalstructuredproductforabehaviouralinvestorwithβ=2 152
5.11 Optimalstructuredproductforabehaviouralinvestorwithβ=1 153
5.12 Optimalstructuredproductofaninvestorwithbiasedperceptionof
probabilities 153
5.13 Interactivemulti-touchtable 154
6.1 ExampleofMarkovmatrices 158
6.2 TheCRRAinvestoronarandomwalk 162
6.3 TAAoftheCRRAinvestoronmeanreversionafter“good’’times 164
6.4 TAAoftheCRRAinvestoronmeanreversionafter“bad’’times 164
6.5 TAAofthebehaviouralinvestoronarandomwalk 167
6.6 TAAofthebehaviouralinvestoronmeanreversionafter“good’’times 168
6.7 TAAofthebehaviouralinvestoronmeanreversionafter“bad’’times 169
6.8 Samplepathsofarandomwalkwithoutdrift 172
6.9 Varianceofrandomwalksovertime 172
6.10 Anexampleofmean-varianceratiosofarandomwalkoverdifferenttime
horizons 173
6.11 Mean-varianceratioofS&P500annuallogarithmicreturns
(1871–2007) 173
6.12 VarianceratiosforS&P500annuallogarithmicreturns(1871–2007) 174
6.13 AssetallocationoftheCRRAinvestoronarandomwalk 176
6.14 AssetallocationoftheCRRAinvestoronmeanreversionafter“bad’’times 177
6.15 AssetallocationoftheCRRAinvestoronmeanreversionafter“good’’times 178
6.16 AssetallocationoftheCRRAinvestoronmeanreversionafter“good’’times
(fix-mix) 179
6.17 AssetallocationoftheCRRAinvestoronmeanreversionafter“bad’’times
(fix-mix) 180
6.18 Assetallocationofthebehaviouralinvestorunderarandomwalk 181
6.19 Thebehaviouralinvestoronmeanreversionafter“good’’times 182
6.20 Thebehaviouralinvestoronmeanreversionafter“bad’’times 183
7.1 PerformanceofGermanstocks(DAX)versusGermangovernmentbonds
(REXindex) 188
7.2 CumulativedividendsfromDAXversusinterestearningsfromREX 188
7.3 Consumptionsmoothing 190
7.4 Utilityderivedfromconsumptiondrawnfromdifferentmentalaccounts 192
7.5 Separatingriskpreferencefromriskability 194
7.6 Perfectconsumptionsmoothing 196
7.7 Theimpactofthediscountfactoroncurrentconsumption 196