Are Investors Rational? And Does it Matter?

Abstract

The principle of 'utility' underpins many contemporary models that aim to represent the operation of financial markets. Various models of utility have been proposed and debated over time and, more recently behavioural finance has started to offer a more individualised model of utility or value. Australia, with nearly AU$1,000 billion in financial assets invested through the highly regulated superannuation system and with over 90% of the working population as participants, provides a large basis for study into investor utility. This paper presents findings of research into investor behaviour when selecting between portfolios with predetermined risk-return and time-horizon characteristics. The research is based on quantitative data analysis of demographics, value and timing of investment selection and of market performance. More importantly, the paper presents results of investor perceptions of their selection activities, a catalogue of events purported to trigger these decisions, and presents results of choice modelling of risk-return and time horizon options - these latter results being used to derive investor utility curves. Investor behaviour was modelled based on results of on an extensive telephonic survey of 238 investors who actively had made (or hadn't made) an investment decision within the previous 12 months. A further study of a superset of over 4,000 members who made an investment selection over a period of 5 years provided the demographic and trend data.