Tuesday, April 23, 2013

Behavioral Finance at Barclays

From Money Science:
Last month I was fortunate enough to meet and interview Dr Greg B. Davies, who first set up and now runs Barclays Bank Behavioural Finance unit, the first such unit in a major bank. Rather like Richard Peterson, the subject of a previous interview, Dr Davies approaches his subject from a truly interdisciplinary perspective. Prior to his work with Barclays, he studied economics, philosophy and finance at the University of Cape Town before completing a Masters Degree in Economics at Cambridge where he also received a PhD in Decision Theory and Behavioural Finance. Besides acting as a consultant on cognitive psychology, behavioural economics, behavioural finance, and decision science, he has lectured in Decision Science at the London School of Economics, was an Honarary Research Fellow at University College London and is presently an Associate Fellow at Said Business School at Oxford University.
Dr Davies is also the author, with Arnaud de Servigny, of the 2012 book. Behavioral Investment Management: An Efficient Alternative to Modern Portfolio Theory published by McGraw-Hill.
In this extended interview Dr Davies talks about his academic background, how that came to be applied in his work for Barclays and his musical collaboration with composer, Alexis Kirke, Open Outcry.

MoneyScience -Thank you for joining us Greg. First of all I thought it might be interesting to talk a little bit about your academic background and how you initially formed an interest in Behavioural Finance.
Greg Davies - To be honest, it was almost completely by accident. I started life studying economics and philosophy and in particular the philosophical underpinnings of economics always interested me a great deal. So, many years later when I had made the decision to go and do a PhD I was actually initially focussed on doing a PhD in pure philosophy. I was going to be studying the philosophy of rationality. I wanted to do a PhD purely because I was passionately interested about the subject, it was never intended to be a career move in any way whatsoever, except possibly into academia. But, as I started reading around the topic of the philosophy of rationality to put together a proposal, I started stumbling across this aspect of the field that I’d never come across before which was; I knew about the rational underpinnings to economic theory, I knew about some of the philosophy of rationality, but I’d not come across any of the behavioural psychology elements and the experimental elements and this just seemed to me to be absolutely the way forward. Suddenly here was something that wasn’t just looking at the philosophical underpinnings but was testing these and asking how do people actually do it? A scientific methodology wedded to some of the deep decision theory in philosophy. It also seemed to me to take on board some of the more practical aspects. By this stage I’d already worked many years as a management consultant, I had some commercial background and this seemed a way to steer my PhD into something that wasn’t purely Ivory Tower, but actually brought in some of my practical finance background and experience. So, suddenly I stumbled across what was effectively behavioural finance and behavioural economics. And quickly swung my PhD proposal in that direction, moved my application from a philosophy department back to an economics department, and that was shortly before Daniel Kahneman won his Nobel prize so it was at the time really still the lunatic fringe of the economics faculty but shortly thereafter took off in respectability and popularity.

MS - So your timing was good!
GD – Yes though I have to say through no foresight or prescience on my part. Serendipity!

MS – You’ve had over a decade of experience in this field now but were there many people at that early stage doing similar work that you were aware of?
GD – There were but those in the UK were fairly isolated. Before then, the only places with academic programs in Behavioural Finance were really in the United States. There were people in the UK that were heading in that direction but they tended to be fairly isolated. Certainly in the economics faculty in Cambridge, where I was, I was the only one doing anything close to that. I did forge links with a number of academics in different universities and departments who were starting to combine these ideas. Most notably in LSE philosophy department, Warwick University cognitive psychology department, and there were a few others but it was certainly very exploratory at that stage still. Which is interesting if you think about it now because it was not that long ago, and there are now dozens of Masters courses in behavioural finance, behavioural psychology, behavioural this that and the other and it’s wonderful that’s happened in a very short space of time.

MS – So from its beginnings as an interdisciplinary area the subject has become a field in its own right?
GD – Absolutely. And some of the challenges back then were more of translation than anything else. You had psychologists and economists working on the same problems, completely independently, talking about the same topics using quite different languages and I used to find myself going to psychology conferences where I would be considered to be hopelessly economic and economics conferences where I was considered to be hopelessly psychological and behavioural, and a large part of what I spent my time doing there was translating these two tribes to each other because actually they were thinking about very similar issues often in very similar ways both with fairly quantitative mathematical models and foundations underpinning them, and both ultimately resting on a critique of Expected Utility Theory. But they were frequently using quite different languages to express the same directional thoughts.

MS – So that process of becoming a discipline means that the language has now become standardised?
GD – It has to an extent. The economic foundations came out of the questions of how do we take expected utility theory and amend it, so it was all model driven. The psychological approach was much more experimental, let’s take a hundred people, split them into two groups and see how they make different decisions, which of course had implications for expected utility theory but the psychologists didn’t start from the theory and work towards the reality, they did it backwards. And many times this is what was happening – you had economists working from theory and incorporating experimental evidence and psychologists starting from experimental evidence and gradually moving towards theory… and not always meeting in the middle....MUCH MORE