Michaud vs. behavioral finance
For work, Dick Michaud develops quantitative investing tools at his Boston-based money management consulting shop, New Frontier Advisors.
For work, Dick Michaud develops quantitative investing tools at
his Boston-based money management consulting shop, New Frontier
By Hal Lux
Institutional Investor Magazine
For fun, he wages a one-man crusade against the trendy academic
discipline of behavioral finance.
In the past year the veteran quant analyst has inveighed
against what he sees as pseudo-science at conferences and
meetings from Cape Town to London to San Francisco. Last month
he brought his campaign to New York.
In a speech to the New York Society of Security Analysts titled
"The Behavioral Finance Hoax," Michaud ridiculed the
behavioralists, contention that quirks in the market can be
attributed to irrational human psychology. Behavioral finance
principles ,including the notion that people irrationally hold
on to falling stocks because they are attached to the original
price they paid , are now widely cited among investment
theorists and practitioners. In recent years such prominent
behavioral finance academics as Richard Thaler of the
University of Chicago and Josef Lakonishok of the University of
Illinois have launched money management operations that attempt
to predict market moves in part with behavioral finance
Michaud says it's behavioral finance, not investor psychology,
that is nutty: "Behavioral finance is something that has been
promoted by a lot of academics. But there's no evidence
supporting these hypotheses. I think these ideas are dangerous
to investors and detrimental to the investment community."
Like many self-styled debunkers of popular theories, Michaud is
a scientist at heart. A former head of equity analytics at
Merrill Lynch, with a Ph.D. in mathematics, Michaud spends much
of his time adapting the statistical techniques known as Bayes
methods, which optimize available data before it is used for
analysis. "I,m a Bayesian," Michaud told his lunchtime crowd of
analysts last month, referring to 18th-century British parson
Thomas Bayes, who developed the techniques. "I,ve always been a
Mixing rigorous finance research with his own flair for
hyperbole, Michaud dismisses the idea that any financial
behavior is driven by the irrational; furthermore, he suggests
that such dramatic claims are often accompanied by a lack of
He argues that ma-ny examples of so-called irrational financial
decision making are not irrational at all. For instance, some
behavioral finance academics say that investors stay
dangerously concentrated in a few stocks because of irrational
impulses. In reality, says Michaud, people may not diversify
because of their limited knowledge. "Not everyone has a
Bloomberg [terminal] on their desk," he says. "Most people only
know two or three stocks. Closely examined, many of these
,crazy behaviors, are quite rational."
Not surprisingly, behavioralists don,t take too kindly to
Michaud's attacks. "I would like to hear a conversation between
him and some employees who lost all their money investing in
only their company stock," says University of Chicago professor
Thaler, who has heard Michaud speak. "Every economist I know
thinks it violates every principle of rational investing to put
all of your money into your company's stock , yet people do it.
If investors don,t have complete information, wouldn,t the
rational strategy be to admit it and invest in readily
available index funds?"
Adds University of Illinois professor Lakonishok, who has not
heard Michaud's attacks: "So he's saying that investors are not
irrational , they,re stupid? You don,t need a whole brain to
know to diversify. Just half a brain."
Michaud, meanwhile, objects to behavioral finance on practical
as well as philosophical grounds. "These ideas are excuses for
poor performance and a way of repackaging investment ideas.
Eventually, these strategies won,t work, and the net effect
will be a pox on everyone."
Not if Michaud can help it. He's determined to get his message
across. He says, "I,m going to give four two-hour talks on the
subject in Boston in the fall."