Traders- Risk, Decisions and Management

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TRADERS

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TRADERS
Risks, Decisions, and Management in Financial Markets

Mark Fenton-O’Creevy Nigel Nicholson Emma Soane Paul Willman

1

Great Clarendon Street, Oxford ox2 6dp Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide in Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan South Korea Poland Portugal Singapore Switzerland Thailand Turkey Ukraine Vietnam Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries Published in the United States by Oxford University Press Inc., New York © Oxford University Press 2005 The moral rights of the author have been asserted Database right Oxford University Press (maker) First published 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. You must not circulate this book in any other binding or cover and you must impose this same condition on any acquirer. British Library Cataloguing in Publication Data Data available Library of Congress Cataloging in Publication Data Data available ISBN 0–19–926948–3 3 5 7 9 10 8 6 4 2 Typeset by Newgen Imaging Systems (P) Ltd., Chennai, India Printed in Great Britain on acid-free paper by Biddles Ltd., King’s Lynn, Norfolk

Acknowledgements

We gratefully acknowledge the help of the investment banks which cooperated in this research and provided financial support, and the Economic and Social Research Council which provided funding as part of the Risk and Human Behaviour Programme (grant number L211252056). We are especially grateful to the traders and managers who gave us their time and shared their understanding.

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Contents

List of Figures List of Tables

viii ix

1

INTRODUCTION
Traders, Markets, and Social Science

1 10

2 THE GROWTH OF FINANCIAL MARKETS AND THE ROLE OF TRADERS 3 ECONOMIC, PSYCHOLOGICAL, AND SOCIAL EXPLANATIONS OF MARKET BEHAVIOUR 4 TRADERS AND THEIR THEORIES 5 A FRAMEWORK FOR UNDERSTANDING TRADER PSYCHOLOGY 6 RISK TAKERS Profiling Traders

28

51 74

110 145 178 197 212 221 237

7 8 9 10

BECOMING A TRADER MANAGING TRADERS CONCLUSIONS APPENDIX
The Study

References Index

List of Figures

2.1 2.2 2.3 3.1 3.2 4.1 4.2 5.1 5.2 6.1 6.2 6.3 6.4

Post-war UK equity market growth Post-war US equity market growth Global growth in OTC derivatives Expected utility theory Prospect theory The relationship between risk and return Idealized trader risk profiles RAT Screenshot Distribution of traders’ illusion of control scores A model of individual risk behaviour Comparisons of personality scores by occupational group Risk propensity, risks taken—now and past Comparisons of risk propensity scores by occupational group 7.1 Career mobility to date 7.2 Likelihood of a career change in the next 5 years 8.1 Introducing incentive and monitoring effects to prospect theory description of risk behaviour

14 15 16 40 41 55 63 104 106 117 132 136 138 174 175 194

List of Tables

6.1 Risk taking index...
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