Eben Otuteye

Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions

Investment decisions are subject to error due to cognitive biases of the decision makers. One method for preventing cognitive biases from influencing decisions is to specify the algorithm for the decision in advance and to apply it dispassionately. Heuristics are useful practical tools for simplifying decision making in a complex environment due to uncertainty, limited information and bounded rationality. We develop a simple heuristic for making value investing decisions based on profitability, financial stability, susceptibility to bankruptcy, and margin of safety. This achieves two goals. First, it simplifies the decision making process without compromising quality, and second, it enables the decision maker to avoid potential cognitive bias problems.

A Transaction Cost and Transformational Generative Model of Aggregate Entrepreneurship

A model of entrepreneurship based on the concept of transformational generative grammar in modern linguistics and transaction cost economics is developed. Using an integrative framework, a number of propositions for conceptualising and studying entrepreneurship both at the micro and the macro levels are discussed. Several policy implications for stimulating aggregate entrepreneurship in the economy are drawn and guidelines for promoting individual entrepreneur-ship are suggested.

An ARIMA model for Canadian Union membership growth, 1911–1985

An ARIMA (1, 1, 0) model for the Canadian union membership growth from 1911 to 1985 is introduced. Predictions for the period 1986–91 are made, and the actual figures for 1986–88 are compared to assess the predictability of the model. Diagnostic checks of the validity of this ARIMA model are also performed.

Examining the Skewness and Kurtosis of Value vs. Glamour Portfolios

We analyze the relationships between higher moments (i.e., skewness and kurtosis) of common stock portfolio returns in the context of how they reflect the behavioral traits or investment style of market participants. Normally, any participant in the stock market is classified as an investor. However, Benjamin Graham, the acknowledged father of value investing, defines investment as an operation that upon thorough analysis promises safety of principal and satisfactory returns. Anything other than that is speculative. We classify investors, or more specifically value investors, as those who make their investment decisions in a manner consistent with Benjamin Graham’s definition. In contrast to Benjamin Graham’s definition, traditional finance theory labels as “investor” anyone who is making choices among financial assets. In this paper, we make a distinction between those who are behaving as investors as defined by Benjamin Graham and those who are making common stock investment decisions that are more representative of gambling behavior. We hypothesize that the common stock portfolio returns of value investors will be more negatively skewed, or at least lower than that of gamblers. Similarly, we hypothesize that the kurtosis of portfolio returns of value investors will be greater than that of gamblers. Using stock returns data from NYSE from 1999 to 2013, we created two portfolios based on price-to-book ratio: one we call quasi value (lowest price-to-book) and the other glamour portfolios (highest price-to-book). We then compared the higher moments of both sets of portfolios. The results show that contrary to what we hypothesized, the returns of glamour portfolios had lower skewness than the quasi value portfolios. However, as hypothesized, the kurtosis of the quasi value portfolios were higher than those of the glamour portfolios. We interpret that to mean that without a full value investing analysis, the extent of diversification of a portfolio is the primary determinant of its skewness.

A Critique of Modern Portfolio Theory and Asset Pricing Models Based on Behavioral Insights from Benjamin Graham's Value Investing Paradigm

Modern Portfolio Theory, the Capital Asset Pricing Model, and the Efficient Market Hypothesis are the cornerstone concepts in both academic and professional curricula. In spite of their long history and reputation, the CAPM and its extensions are not able to yield satisfactory empirical results. We argue that this is because the modelling process ignored the impact of human behavior in financial markets. We present a critique of these standard models using behavioral insights from Benjamin Graham’s value investing paradigm. We propose that if, instead of getting fixated on investors’ optimal rational decision making, we adopt Benjamin Graham’s value investing perspective which explicitly acknowledges that investor decision making is by definition imperfect primarily due to psychological biases, we would be able to derive better investment decision making processes.

Re-Evaluating the Value of Modern Portfolio Theory and Asset Pricing Models Based on Behavioral Insights from Benjamin Graham's Value Investing Paradigm

Modern Portfolio Theory, the Capital Asset Pricing Model, and the Efficient Market Hypothesis are cornerstone concepts in both academic and professional curricula. In spite of their long history and reputation, the CAPM and its extensions do not yield satisfactory empirical results. We argue that this is because these models ignore the impact of human behavior in financial markets. We present a critique of these standard models using behavioral insights from Benjamin Graham’s value investing paradigm. We propose that if, instead of getting fixated on investors’ optimal rational decision making, we adopt Benjamin Graham’s value investing perspective which explicitly acknowledges that investor decision making is by definition imperfect due to psychological biases, we could derive better investment decision making processes.

Avoiding Financially Distressed Companies Using a Simple Value Investing Heuristic

This article presents a value-investing heuristic based on a set of financial ratios rooted in Graham and Dodd’s [1934] definition of investment. We show that, by using this heuristic, an investor will avoid 100% of companies that become insolvent or experience some form of financial distress.

Redefining Risk from a Value Investing Perspective: Propositions to Motivate a Re-Examination of Standard Portfolio Theory and Asset Pricing Models

Modern Portfolio Theory and Asset Pricing Models have major limitations as systems for modeling investor portfolio choices and prices of financial assets. Financial market participants are not a uniform group of rational investors. Instead, they are an amalgamation of heterogeneous traders with varied and sometimes very divergent goals. In fact, not every financial market participant is an investor. Even the investors in the market operate in a manner such that a lot of decisions do not line up with rationality. Thus the current paradigm of using Modern Portfolio Theory to represent the activities of market participants as rational investors leads to predictions that do not fit what is observed in financial markets. First, we define investment and an investor from a Value Investing perspective according to Benjamin Graham. We present a number of propositions based on critiques of Modern Portfolio Theory that are becoming common in the literature to focus discussion on ways to view investment operations from a value investing perspective as propounded by Benjamin Graham. These propositions deal mainly with how investors perceive and handle risk in their portfolio management decisions. We conclude that we have the tools and methodology to develop portfolio theory that incorporates time and investor behavior that is different from the homogeneous group of ultra-rational decision makers on whom the current models are based.