IngentaConnect Chapter 14. Fixed Income Securities: The Full Measure of Behavior...

Abstract:

This chapter discusses some of the successes and failures associated with the management of fixed income securities, first by presenting a case, and then by discussing some general issues associated with yield curves. The chapter focuses on all three themes: heuristic-driven bias, frame dependence, and inefficient markets. In order to illustrate the key issues, the chapter details the experiences of the Orange County Investment Pool. This case is exceedingly rich in behavioral phenomena. At the beginning of the case, the most prominent phenomena are overconfidence, gambler's fallacy, and betting on trends. As the case progresses, emphasis shifts to conservatism, hindsight bias, loss aversion, and regret. The case is very complicated. After discussing the Orange County case, the chapter moves to the general issue of market inefficiency. Many scholars believe that in an efficient market, yield curves should satisfy a property known as the expectations hypothesis. But the evidence indicates that in practice, yield curves fail to satisfy this property. The discussion focuses on a behavioral explanation for this failure. In this respect, the most important behavioral element is conservatism. Specifically, anchoring and adjustment gives rise underreaction, particularly in connection with expectations about future rates of inflation. Underreaction interferes with the forces that would otherwise induce yield curves to satisfy the expectations hypothesis.

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Chapter 14. Fixed Income Securities: The Full Measure of Behavioral Phenomena