Beyond Greed and Fear

Shefrin, an academic who worked with Meir Statman on behavioural portfolio theory, wrote this to translate behavioural finance research into terms practitioners could use.

The organising framework has three themes. Heuristic-driven bias covers the mental shortcuts that produce systematic errors: representativeness, which causes investors to judge a company's stock by the company's quality; overconfidence in one's own information and judgement; anchoring on prior prices; and availability, which causes recent and vivid events to dominate assessment. Frame dependence covers the finding that the way a decision is presented changes the choice, including loss aversion, mental accounting that separates money into categories treated differently, and the disposition effect, meaning the tendency to sell winners and hold losers. Inefficient markets covers the resulting asset pricing consequences.

The applications are what distinguish the book. Shefrin applies the framework to individual investors, to professional money managers whose own biases affect their decisions, to analysts whose forecasts show predictable patterns of over-optimism and slow revision, to corporate managers making capital budgeting and acquisition decisions, to options markets, to the equity premium through myopic loss aversion, and to financial advisers managing clients.

His behavioural portfolio theory, developed with Statman, argues that investors construct portfolios as layers corresponding to separate goals rather than as a single optimised whole, which explains why people simultaneously hold insurance and lottery tickets and why they resist the mean-variance framework.

The book is from 2000 and the field has developed since. Some of the studies cited come from literatures affected by replication problems. The disposition effect, the analyst forecast patterns and the mental accounting findings have held up well. Shefrin writes clearly and the practitioner orientation makes it more usable than the academic collections.