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• 1 Shota Zhvania // Feb 5, 2009 at 5:59 am

  Dear Mr. Kumar,

  I had a pleasure of reading “Anatomy of Investor” article published at http://www.utexas.edu/features/2009/01/26/investors/ by Tracy Mueler of Red McCombs School of Business making reference to your research, and in particular to a controversial statement of:

  quote
  New research by Alok Kumar, assistant professor of finance at the McCombs School of Business, shows these factors—geography, age and even whether or not you gamble—play a key role in how individual investors choose stocks.
  unquote

  Being an investment banker and having surpassed the investment activity of more that 3 years, and real-life experience with investment decisions, regional diversifications, credit risk, exposure management, sovereign risks, appraisals, due diligence, etc. I must disagree with the general motif of your research. The “key role” - as generously put by Ms. Mueller - in investment decisions is by far not vested upon demographics of age or backgrounds of origination or gambling attitudes. In fact, most - if not all - investment decisions, ranging from the SME credit lines to sovereign bonds, are profoundly made considering transaction economics, rates of return, tenors, complex risk assessments, legal implications and particular terms of investments (like market disruptions, call/put options, flex, clawbacks, tax withholdings, repayment proceedings, prepayment rights, and so on).

  You may be right in suggesting the “personality, age and background” adhere to the general behavioural patterns of the investors, causing certain bias towards investing in particular papers, loans, funds, but such bias is never encouraged by the general policies of the investment boutiques while they are cherry-picking from the different investment opportunities worldwide. Put it simply, ceteri paribus, why would an investment house from the US invest in any given A paper from the US while it could receive triple rate of return from the same A level risk originating from Romania, or double rate of return from the Middle Eastern investments, or often times - quadrupled returns from investments in sovereign Russian notes?

  If sampling a selection of individuals to derive the impact of personality/biography on the investment gives us: “there’s no reason to believe that suddenly when you start to invest, you become a different person” I’d beg to hold this as a universal truth that does not require such a scrupulous research. Out of 70,000 questioned anonymous investors (individuals by their nature), how many would have made an absolutely independent decision? And if some of them are independent decision makers, would they represent the statistically significant group you could make your assumptions on? Fact is, on a large scale, individuals do not make the investment decisions. Most of the times, such decisions are subject to the rigorous selection process, due diligence, exposure/limit availability, committee/board approvals, finally - economics of the transaction. All this involves hordes of investment oriented minds (all of them with different social backgrounds) who jointly make a decision to make a particular investment. Selection process aside, there are procedures that one has to pass through in order to make an investment. If you had a closer look at the multinational investment environment where no two bankers share the same origins or behavioural attitudes, you would fail to draw analogies between personal traits and the investment activities.

  Further, you mention:

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  The reality is that in any given year, some states are really falling behind, and some are doing really well… What we show in this paper is that states that are lagging behind are states in which people are not making good financial decisions. They’re investing, but they’re not doing so in a sophisticated way—their local biases play a major role in this.
  unquote

  I am surprised at the conclusion you make about the soundness of financial decisions and their impact on the states, which to my taste is too far-fetched. Every single financial decision has probability of failure - it’s called risk (in all its forms: credit, repayment, operational, liquidity, legal, sovereign, etc.). And while risk assessment is considered to be art (at least this is what any risk analysts will tell us) none can guarantee the perfect rationale of return vs. non-payment. In this regard, I am glad you brought the example of the subprime mortgage, which actually contradicts profoundly your statement above. I.e.: who would have thought that the states outperforming through 2006, would have been hit by crisis in 2007 and 2008? Would you have considered their financial decision-making related to subprime as “sound” back in 2006? How about 2005? Or even 2004 for that matter? Following your line of argumentation I would deduce (hypothetically), that at any given year - let’s take 2006 as example - the state of ABC outperformed the state of XYZ heavily investing in subprime mortgage. Well, it turns out their investments in 2007-2008 plunged the economy of the whole country (including that of XYZ) causing systemic shocks through sectors of financial intermediation, recession, and ultimately financial crisis.

  I am also disappointed at your conclusion:

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  The subprime mortgage collapse is a perfect example of the dramatic effect even small entities can have on the market. Many individuals make similar mistakes at the same time, and thus the effect of those mistakes is amplified.
  unquote

  Apparently, it lacks the general considerations related to systemic risks (so eloquently called - information asymmetry), and in particular the nature of securitisation, ABS, repackaging, and secondary market sales. Individuals making mistakes at the same time cannot cause crisis. Again, individual behaviour is substance of insignificance to the system (financial in this case). What amplifies effect on the market is the system of arrangements itself, not the small entities who wrongly take mortgages they cannot repay or individuals who repackage them into market appealing instruments. In this regard, I would kindly suggest making reference to the analysis of systemic behaviours and work of Niklas Luhmann.

  Last, but not least:

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  The bottom line is that how our society behaves ultimately affects financial markets and perhaps even the broader economy… In other words, what happens on Main Street has the potential to affect what happens on Wall Street.
  unquote

  By this you are making the reference to social behaviour - a substance itself very vague and undefined - while trying to blame it for the shortcomings of the financial market. While it is fairly easy (and comfortable) to put the blame upon the social behaviour, I would suggest nothing in the published article (and I presume in the research) would present a solid, undisputable evidence of behavioural impacts on the financial markets, or economy as a whole. Unfortunately, supporting an assumption (in this case: something affecting financial markets) with another assumption (in this case: the traits of social behaviour) does not add validity to your line of argumentation. Even if we admit for a moment that social behaviour as such can be meaningfully identifies, correlating the virtues of its impact on the market or economy would have been only valid (questionably though) in authoritarian/utopian state of uniform behavioural patters, but not under the current market arrangement.

  On the side note of this, and reverting to the initial problematic of “anatomy of investor” I’d agree there are certain personality, age and background influences brewing the mind of a randomly taken investor, but none of these do lead him/her in the actual investment decisions.

  Kind regards,

  Shota Zhvania

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