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Behavioral Biases and Factor Anomalies

Top Papers on Factor Investing and Behavioral Bias

To what extent do behavioral biases relate to investor preferences that are expressed via factor anomalies?  The below papers examine the connection between these topics, spanning everything from evolutionary psychology and heuristics for investors, to instructions on navigating through the factor zoo to determine factor significance.   

Also, in the first paper below, CFA Institute Research Foundation attempts to reconcile behavioral finance with classical financial theory by introducing a popularity framework that encompasses investor preferences of both a rational and irrational nature. 

behavior bias anomalies

Popularity: A Bridge Between Classical and Behavioral Finance (CFA Institute Research Foundation, 2018)

CFA Institute Research Foundation examines the differences between classical finance and behavioral finance and introduces 'popularity' as a framework for bridging the gap between the two fields.

Podcast: Inside the Mind of a Quant, Part 1 (State Street, 2018)

In this podcast, State Street discusses market inefficiencies resulting from behavioral biases of investors such as the endowment effect, herding, and the lottery effect, and the insight that their active equity investment teams can draw from them.

Factor investing in corporate bonds - client cases (Robeco, 2018)

The same forces that make factor investing work for equities are also applicable to other asset classes. In this paper, Robeco presents client cases that illustrate different rationales for implementing factor credit solutions.

Invesco Global Factor Investing Study 2018

Invesco's 3rd annual Global Factor Investing Study is based upon interviews with over 300 institutional investors and is the largest in-depth analysis of global factor investing.

FTSE Fixed Income Factor Research Series – The Value Effect (FTSE Russell, 2018)

FTSE Russell looks at the value factor in fixed income, using an OAS framework to designate undervalued and over-valued securities. This study focuses upon the US investment grade corporate bond market.

Taming the Factor Zoo: A Test of New Factors (2019)

The authors propose a method for evaluating the explanatory power of new factors and their contribution to asset pricing, thereby weeding through the factor zoo to determine which factors are most significant.

A Multi-Factor Strategy for Index Enhancement (QMA, Dec 2018)

This study proposes a multi-factor approach to outperforming an index by removing both 'lottery' stocks and 'safety' stocks.

Factor investing: get your exposures right! (BNP Paribas AM, 2018)

This paper is devoted to the question of optimal portfolio construction for equity factor investing. It demonstrates how to make sure that a given equity portfolio has the targeted factor exposures, even before imposing any constraints.

Achieving your investment goals with factors: get specific factor exposure (Robeco blog, 2018)

This is the 5th article of a series on how factors can help investors achieve specific goals. Links to the other articles in the series are available at the end of this article.

Factor Indexes and Factor Exposure Matching (FTSE Russell, 2018)

The authors calculate factor exposures of S&W portfolios and then replicate those exposures using the FTSE Russell factor tilt methodology, allowing the construction of competing factor tilt portfolios that differ in terms of weight but have precisely matched factor exposures.

Factor-based challenges (LGIM, Sep 2018)

For compliance reasons, this paper is NOT accessible in the United States and Canada

There are so many elements to consider when building factor-based solutions it can be overwhelming. We’ve highlighted two case studies of investors tackling these challenges.

The Revenge of Traditional Investment Research and the Persistence of Financial Anomalies (FactSet, Dec 2018)

If anomalies in investor behavior are both persistent and observable, investors should incorporate this information into their decision-making, financial plans, and portfolio construction.

Ignored Risks of Factor Investing (Research Affiliates, 2018)

Long-only factor investing can be a valuable way for investors to achieve their long-term return targets, but investors should have realistic expectations about the risks factors posed and be prepared for potentially prolonged periods of underperformance.

Beat Your Biases to Boost Manager Selection (eVestment Blog)

In this guest post by Mark Thurston, behavioural biases are explored to determine the effect that they can exert on performance.

Crowded Trades: Implications for Sector Rotation and Factor Timing (State Street/MIT, 2018)

The herding effect can lead to overcrowded trades, and eventually form bubbles in certain assets or sectors. This paper looks at how to identify bubbles, as well as how to exit from them in a timely fashion.

Factors and Behavioral Biases: Lessons from the Stone Age (LGIM blog, May 2018)

For compliance reasons, this paper is NOT accessible in the United States and Canada

Evolutionary psychology highlights a Stone Age mentality hardwired into our brains and reflected in our behaviour and habits, potentially explaining certain behavioral biases demonstrated by investors.

Five Investing Biases and Heuristics to Watch For (AB blog)

For compliance reasons, this paper is only accessible in certain geographies

AB discusses irrational human behavior and presents five common biases and heuristics—mental shortcuts—to be on the lookout for.