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Psychology-Based Investment Strategies

Module Details
Audience: Money managers, financial advisors, traders and investors.
Duration: 4-8 hours (2 days is preferred; minimum 4 hours)
Location: Miami Herbert Business School, University of Miami


The recent academic literature in behavioral finance has identified a large number of profitable trading strategies that exploit different types of market inefficiencies. These inefficiencies typically emerge from various psychological factors that induce investors to behave in a sub-optimal manner. If these deviations from optimality are correlated across individuals in the market, they can generate market forces that induce predictable patterns in stock returns. In addition, sociological factors (e.g., social biases such as discrimination, stereotyping, etc.) can be important determinants of these inefficiencies.

The goal of the seminar is to provide a comprehensive summary of these interesting trading strategies that emerge from various psychological and social factors. Several case studies will be used to provide examples of market settings where money managers have effectively used some of these trading strategies. The seminar will also discuss the economics behind these strategies and explain why they might work. Thus, the seminar should appeal to practitioners as well as individuals with an academic mindset.

Here is a rough outline of the topics that will be discussed in the seminar:

  1. Efficient Markets
    We will start with an intuitive understanding of the theoretical foundations of the efficient markets hypothesis. I will also discuss how arbitrage forces are expected to “discipline” the market and also why sometimes arbitrageurs become ineffective. 
  2. Inefficient Markets: Foundations of Behavioral Finance
    The goal of this section is to provide a micro-level foundation to the trading strategies discussed in this seminar. In particular, I will summarize the different types of biases that various market participants are likely to exhibit (e.g., overconfidence, disposition effect, confirmation bias, familiarity bias, anchoring, gender bias, stereotyping, discrimination, etc.). I will also explain how psychological and social factors can potentially affect market prices.
  3. Well-Known Anomalies: “Old” Trading Strategies
    Before discussing the “new” trading strategies, I will discuss the trading strategies that have been popular in the industry.
  4. Trading Strategies that Exploit the Informational Advantage of Institutional Investors
    A large number of studies have examined whether relatively more sophisticated institutional investors possess an informational advantage. This section will use this literature to identify a set of trading strategies that may allow other investors to potentially exploit the collective informational advantage of institutions.
  5. Trading Strategies that Exploit Behavioral Biases of Retail Investors
    A growing literature in behavioral finance has identified different types of behavioral biases among individual investors. Recent studies have also established that those biases are likely to aggregate at the market level. This section will first describe those biases in detail and then discuss a few trading strategies that could attempt to exploit individual biases that are more likely to aggregate at the market level. 
  6. Trading Strategies that Exploit Biases in Analyst Forecasts
    The recent finance and accounting literature has identified a large number of biases among sell-side equity analysts. In addition, due to various frictions and investor biases, analysts’ opinions are not incorporated into prices immediately. Trading strategies can be designed to exploit these types of inefficiencies in the market. 
  7. Corporate Events-Based Trading Strategies 
    Recent studies in behavioral corporate finance have identified instances of market mis-reaction (over-reaction or under-reaction) to various types of corporate events. This section would first summarize those findings, provide an economic explanation for each of them, and then suggest methods for exploiting them.
  8. Geography-Based Trading Strategies
    Several papers in behavioral finance have emphasized the importance of geography. Location matters! This part of the seminar will summarize the findings from those studies and will focus on a few strategies that can be constructed based on those results. 
  9. Demographics-Based Trading Strategies
    This section will highlight another aspect that is common in recent behavioral papers: importance of investor demographics. There are systematic differences in the investment behavior of individuals, which can be attributed to their demographic characteristics. I will summarize those differences and then explain how trading strategies can be constructed to exploit the aggregate effects of those demographic differences.
  10. Media Based Strategies
    There is a small but growing behavioral finance literature on the role of media. In this part, I will explain how the media can influence the behavior of the market. In particular, I will discuss how qualitative information, media slant, etc. affects the market’s perception of information.
  11. Technical Trading Strategies
    A large industry in finance specializes on developing technical trading strategies using a variety of pattern recognition tools such as neural networks and genetic algorithms. This section will attempt to provide an economic story for why those strategies may work. In addition, I will discuss which of these technical trading rules are likely to work in the future.
  12. Trading Ideas
    In the last part of the seminar, I will speculate a bit and discuss some ideas that may work in the future. There may be some empirical support for these ideas but they have not been fully tested. These ideas may motivate the reader to think about related trading strategies.
  13. The Future
    I will end the seminar with a brief discussion about what we can say about the overall market behavior based on the topics discussed above. How do we expect the market to evolve in the future? Will these types of trading strategies work in the near future if many individuals start implementing them?


Alok Kumar

Professor Alok Kumar is the Gabelli Asset Management Professor of Finance at the Miami Herbert Business School, University of Miami and a part-time Professor of Finance at the Warwick Business School in the U.K. Previously, he was an Associate Professor of Finance at the McCombs School of Business, University of Texas at Austin, and an Assistant Professor of Finance at the Mendoza College of Business, University of Notre Dame. He was also one of the founding principals and the chief investment officer of Coral Gables Asset Management.  Professor Kumar received his undergraduate degree in Mechanical Engineering from the Indian Institute of Technology at Kharagpur and a PhD in Economics from Cornell University. He also has advanced degrees in Robotics and Management from Dartmouth College and Yale University, respectively.

WBS Distinguished Research Environment

Professor Kumar’s research interests lie at the intersection of finance and psychology. He is an expert in the area of Behavioral Finance, and his work has appeared in top Finance, Accounting, Economics, and Management journals such as the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, the Journal of Accounting Research, Management Science, Games and Economic Behavior, and The Review of Economics and Statistics. His research has also been covered in the Wall Street Journal, the New York Times, the Washington Post, the Montreal Gazette, Forbes, and SmartMoney. Professor Kumar has served as a consultant for several firms, including the Commonfund, Postnieks Capital Management, Validea, and Bluecrest Capital.

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