Professor Lisa Kramer did not set out for an academic career in psychology but over the past decade the field has figured more prominently in her finance work within the Department of Management. She can attest to the fuller picture that forms from combining the two relatively disparate areas of research.
“In finance, there are theories and models built on mathematics, but when people test them in real life, they do not always work,” says Kramer, who is also based at the U of T’s Rotman School of Management. “In blending the fields of psychology and finance we can see the role human behaviour has on our actions. People making financial decisions try and do what they think is optimal but their behaviour is not always based on the models. Researchers have recently begun to draw on insights from psychology to explain financial decisions.”
One of Kramer’s first publications in the area, in 2003, dealt with how the seasons affect the stock markets through a form of seasonal depression known as Seasonal Affective Disorder (SAD) in its most extreme form. Kramer and her co-authors find evidence that suggests seasonal depression has an impact on people’s willingness to tolerate financial risk, for example influencing portfolio allocation choices between government bonds (a relatively safe investment) and stock investments (being more risky). She has also taken a page from psychology and is looking at individuals over a long period of time, trying to understand their decision-making processes and the human behaviour involved with handling financial matters.
Kramer indicates that financial models also need to incorporate the human-behaviour factor for important decisions, such as retirement planning. “When stock market prices are moving downward, people often have the urge to sell their risky financial investments in favor of safer alternatives, but once markets settle, prices can rebound very quickly, making it difficult for investors to resume their holdings without taking a costly financial hit,” says Kramer. “This research seeks to encourage people to avoid making drastic decisions when they feel extremely emotional and when their urge to make financial decisions is often at its strongest.”
Kramer’s findings with respect to individuals’ seasonally varying risk preferences have important implications. Specifically, individuals who become more risk averse in the autumn may feel an urge to switch to more secure investments like government bonds. Since there is commonality across individuals, with many people simultaneously experiencing the same urge to avoid risk, the rate of return on safe investments can become very low at that time of year, a fact investors need to keep in mind. This research has far-reaching results for the financial sector, and will also help people to properly plan their investments and be aware of the effect the seasons have on them and their portfolios.
Kramer notes that the trend of blending finance and psychology is expanding in academia, and that the public at large finds this information useful. “It’s natural for people to speculate about the causes of financial crises and the factors that underlie investor decisions during emotional times. I hope my research can help shed some light on such matters,” says Kramer, adding that “there has been some interest in my work from the community that professionally manages portfolios and from the popular press.” Kramer says seeing her interviews translated and featured by media outlets in other countries such as Germany and Denmark takes some getting used to, and she is still adjusting to the broad range of interest that has developed from her research.
The proclivity for combining psychology with finance began with Kramer’s conversations with graduate advisors at the University of British Columbia, and she finds both fields to be inspiring, while also recognizing the great value in the interdisciplinarity and collaborative nature of her work. “There are appealing characteristics of both communities, and it can be really stimulating to look at other fields,” says Kramer. “Often in the individual fields, researchers are studying the same problem but they have different perspectives for looking at it, and I encourage others to explore interactions across disciplines, as the outcome can be extremely rewarding.”
By Andrew Dmytrasz