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(More customer reviews)For most of the 17 years in which I held an endowed chair in a leading finance department. I required that my doctoral students read Fischer Black's Presidential Address to the American Finance Association titled, "Noise." In that paper, Black, a co-inventor of option pricing theory who later worked for Goldman Sachs, stated that stocks could be priced anywhere from 2 times to ½ the value suggested by market efficiency considerations. Black attributed the large deviations from market efficiency to trading "noise." Richard Peterson's book, Inside the Investor's Brain, is important because it gives rational explanations for market inefficiencies and "noise" based upon well-documented neuroeconomics findings.
While the book has a high level of professional sophistication, fortunately, it contains a useful glossary to acquaint the reader with technical terms in medicine or finance with which the reader may be unfamiliar. Furthermore, because the author has traded extensively, worked with hedge funds, and, as a psychiatrist, has counseled financial market traders, the book contains numerous practical trading and investing examples and cases to illustrate its points, which makes it interesting and fun to read.
The book contains many practical insights that can help participants in the financial markets. By understanding and controlling their emotions, investors and traders may be able to use Peterson's insights to invest more successfully. Toward that end, Peterson explains how can monitor and control the impact of their emotions on their investment decisions.
Some of the findings presented in Peterson's book help resolve theoretical anomalies in finance. For instance, he cites research that shows that people typically weight losses twice as heavily as gains in their decision making; and, consequently, peoples' decisions are made differently if they are "framed" in a loss-taking versus gains making context. A major reason for this difference is that different parts of peoples' brains are engaged when considering potential losses rather than considering potential gains. Depending upon which part of a person's brain is engaged, people will behave differently--which can explain why people and markets typically behave differently in "bull" versus "bear" markets, and why many people both buy insurance and gamble.
Peterson also shows that the workings of the "rational" planning part of the brain, the prefrontal cortex, can be inhibited or bypassed by emotions stemming from other areas--such as greedy gain anticipations coming from the Nucleus accumbens or by "fearful" emotions emanating from the brain's amygdala. Acting under the influence of fearful emotions, people may exhibit excessive loss aversion and enhanced time preference. Acting under the euphoric input of greedy anticipation, people may make hurried, impulsive decisions and forego doing due diligence before investing. Rational decision making and asset pricing suffers in either case, and so will market efficiency when "herding" occurs and people respond similarly to market stimuli.
The book provides both trading and investing references and tips for recognizing emotional states that can affect markets or personal investment success. Market inefficiencies can be generated by the emotional states of others, while personal emotional states can be inimical to successful trading or investing. The book provides advice to help investors recognize and control their own emotions while investing.
It also may help them profit market inefficiencies generated by pervasive emotional states of other investors. The book should be valuable both to investors and academics because it contains voluminous recent references to the rapidly developing literature in behavioral finance and neuroeconomics as well as to recent literature in psychiatry and psychology with financial applications.
Chip Peterson
Professor Emeritus (Finance), Texas Tech University
Click Here to see more reviews about: Inside the Investor's Brain: The Power of Mind Over Money (Wiley Trading)
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