Last week I had the pleasure of meeting Simon Russell, author of Applying Behavioural Finance in Australia, for a cup of coffee. It was great to meet a fellow investor with a background in the social sciences. Don’t get me wrong, I like quants, actuaries and CPAs, but occasionally its nice to talk to someone that speaks my language.
Simon has graciously allowed me to his chapter on the Value Effect here on Market Fox.
What I like most about Simon’s book is that he focuses on the application not just the theory. The book is also full of personal anecdotes that help to bring the material to life.
The chart below is a summary of the chapter. It shows that the Value Effect can be explained by a combination of forecasting error, our subconscious emotions, probability effects (our bad habit of overpaying for “lottery stocks”) and career risk.
The section on subconscious emotion is an important one as it highlights how easy it is for our emotions to pull a “bait and switch” on us when we’re making investment decisions. This is known in psychology as attribute substitution.