Moran, Paul Anthony (2020) Do Investor Beliefs About Asset Returns Produce Rational Financial Behaviours? PhD thesis, Victoria University.

Abstract

Introduction - Why do investors choose one investment over another? When comparisons are readily available the answer is assumed to be the one that provides the best expected return for the least risk, but when comparisons are difficult or non-existent due to inadequate or confusing data how do investors choose? Purpose - This research considers the question of how Australian non-professional investors select between three common Australian investment options – Superannuation, Australian shares and Residential real estate to determine whether investors have a rational view, that is, that they sufficiently understand the risks and expected returns of specific investment characteristics, and then whether this view influences their investment actions in a rational or irrational manner. Critical Literature Review and the Contribution - Utility maximisation, according to Von Neumann and Morgenstern (1964), is the basis of traditional finance and economics and Markowitz (1952) suggests that investors make investment decisions based on an optimal balance of risk and return. Behavioural finance and economics have questioned the rational man approach by identifying persistent anomalies in the decision-making process. Prospect theory (Kahneman & Tversky, 1979) was the basis of the concept of loss aversion and their further work built on an understanding of the impact of 'framing'. Simon's work on bounded rationality (Simon, 1955) suggested that people self-limited new information that did not accord with their already held beliefs. Financial literacy has been considered as a solution for the irrationality of investment decision making as wealth and financial literacy has been found to be correlated (Hastings & Mitchell, 2011; van Rooij, Lusardi, & Alessie, 2012). Methodology - An online, quantitative survey was conducted using a random selection of candidates sourced through social media and an Australian Financial Planning Association. The survey was administered using QUALTRICS software and usable responses were elicited from approximately 280 respondents. Descriptive statistics, correlation testing and logistic regression analysis was conducted to investigate the research questions. Results, Discussion and Implications - The sample was identified as being financially literate yet showed a poor understanding of the relationship between risk and return as measured by a mean-variance approach. Significant differences were identified when considering investing framed by past performance compared to framing by expected future performance Respondent's perception of the best past performer of the three options was poor with more than 60% choosing a different option than the one which produced the actual best past performance. Notwithstanding this, the perception of past performance was a significant factor in respondents selecting their preferred investment. As respondents were not provided with information regarding actual past performance, this research has focussed on perceptions. The impact of the perception of past investment performance is the most important factor in investment choice decisions by Australian investors. Conclusion - This research questions the efficacy of relying on a mean-variance approach to assessing an investor's tolerance for risk without considering their already held beliefs regarding the perception of risk and past performance of investments considered. The research suggests that participants were ignorant of the relative risks of the investment options considered, and indeed when combined with an inability to identify past performance accurately suggests the dangers of relying on naïve investors to provide for their financial future. The challenge of comparing investments that have unlike characteristics (fundamentally different risk and return profiles) has been highlighted and requires further investigation.

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