Wipplinger, Evert

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Financ Mark Portf Manag (2010) 24: 103–104DOI 10.1007/s11408-009-0127-9B O O K R E V I E WWilliam Forbes: Behavioural FinanceWiley, 2009Evert WipplingerPublished online: 22 January 2010© Swiss Society for Financial Market Research 2010Behavioral finance was an integral part of financial theory even before Kahnemannand Smith were awarded the 2002 Economics Prize in honor of Alfred Nobel for theirwork in this field. The topic is a difficult one, but William Forbes’s Behavioural Fi-nance textbook will facilitate the study of this very diverse and complex field. Profes-sor Forbes, who teaches at Loughborough University (UK), merges both recent andfundamental scholarly models in assessing the applicability of this theory to practice.The scope of the book is comprehensive, ranging from utility theory and psychologyto human financial decision making and empirical puzzles of standard financial the-ory. In discussing behavioral finance, the author often chooses a renowned scholarlymodel, discusses it, sometimes presents a numerical example, and then shows whichfacets of human financial behavior the model captures. Each chapter features learn-ing goals and questions for students as well as an extensive reference list. Additionalteaching material is available on the publisher’s website.The book itself is comprised of an introduction and four parts. The first part,“Foundations,” introduces basic intertemporal utility theory and Bayesian learning.Utility theory as a framework for rational agents is presented rather cursorily and stu-dents may be well advised to supplement Forbes’s treatment with another textbook,especially since the subject is discussed several times in the text. Moreover, new fea-tures of utility theory are introduced throughout the book. In the chapter on Bayesianlearning, the author presents Bayes Law and relates it to empirical findings on howinformation is processed in practice. This first part of the book also includes a chapteron financial bubbles, which essentially provides anecdotal evidence on the existenceof bubbles, without much focus on the theory behind them.E. Wipplinger ()Swiss Institute of Banking and Finance, University of St. Gallen, St. Gallen, Switzerlande-mail: evert.wipplinger@unisg.ch104 E. WipplingerIn the second part of the book the author deals with asset pricing. Noise tradermodels and prospect theory serve as the workhorses of this section and each receivesa separate chapter. Noise trader models include informed and uninformed agents andthese agents may differ in how they process information. This model is the subjectof much scholarly work, which is cited in subsequent chapters. A similar model isthat of Odean, which the author uses to discuss overconfidence of investors. Prospecttheory is at the very core of behavioral finance and Forbes discusses several variationson the theory, including those of its founders, Kahnemann and Tversky, as well as thework of Barberis and Huang. The subsequent chapters in this part deal with appliedproblems, namely, overreaction, momentum, and herding. Professor Forbes describeseach phenomenon with a detailed research model and provides insights into whatbehavior the models are able to reproduce. The final chapter of Part 2 covers howbehavioral finance deals with the equity premium puzzle.Part 3 elaborates on the corporate finance aspects of behavioral finance. This sec-tion of the book relies less on scholarly models than the other sections and moreon stylized facts generated from, e.g., prospect theory. It starts with arguments forthe existence of companies and a general discussion of corporate governance andthe principal–agent problem. One chapter explains how market participants processinformation. Behavioral finance approaches to explaining dividend policies are dis-cussed separately. The last chapter is especially notable for covering self-control ver-sus self-confidence from the perspective of an entrepreneur, an aspect of behavioralfinance rarely found in textbooks.In the fourth and final part of book on “The Professions,” the author returns toprincipal–agent problems, this time looking at them from an accounting and regula-tion perspective. This part of the book includes many instructional cases, some drawnfrom the recent credit crisis.Compared to what I expect from a textbook, I found each chapter’s introductionand comments written a little too colloquially for my taste. This may be appealing tosome readers but I found that the style distracted me from the principles the author istrying to explain. Additionally, the sometimes very long case studies should be readwith a grain of salt since alternative interpretations receive little attention. However,nearly every statement is backed with citations, if not from scholarly research thenfrom other sources of literature. The author covers all prominent examples of howbehavioral finance deviates from standard rational theory in detail, but the modelsare explained, perhaps by necessity, in a rather sketchy manner. Hence I advise thatteachers using this textbook supplement it with additional information on the scopeof the models. The book excels when it discusses how scholarly models are appliedto capture observed human behavior. In summary, William Forbes’s Behavioural Fi-nance is an accessible textbook with a focus on stylized facts encompassed withinselected reference models of behavioral finance research.

William Forbes: Behavioural Finance: Wiley, 2009

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William Forbes: Behavioural Finance: Wiley, 2009

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