Abstract
Human investors are supposed to be rather emotional and prone to biases in their financial decision-making. By contrast, robots and algorithms have the reputation to be fully rational and therefore are very often considered as ideal investors. But since they are programmed by humans, the question arises how unbiased algorithms and robots really are. We analyze robo-advisors with respect to home bias, mental accounting, and overconfidence and find that the recommendation from robo-advice is not free from behavioral biases. After all, it seems that robo economicus is not as close to the model of Homo economicus as supposed.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
- 2.
Translation from German to English by dict.leo.org.
- 3.
Based on the assumption that the investment committee makes similar decisions in their ETF portfolio and the robo portfolio.
- 4.
- 5.
Vanguard: “When recommending, setting, and adjusting your asset allocation, we weigh shortfall risk—the possibility that a financial plan or Portfolio will fail to meet longer-term financial goals—against market risk.” Schwab: “[W]e have dedicated an entire team of Charles Schwab Investment Advisory (CSIA) experienced analysts to continually use state-of-the-art research and evolve our approach to creating asset allocations designed to improve outcomes for individual investors.” Wealthfront: “Wealthfront combines the judgment of its investment team with state of the art optimization tools to identify efficient portfolios.”
- 6.
Vanguard Advisers, Inc. (2019, p.18): “When recommending, setting, and adjusting your asset allocation, we weigh shortfall risk—the possibility that a financial plan or Portfolio will fail to meet longer-term financial goals—against market risk.”
References
Alan Ahearne, William L. Griever, and Francis Warnock. 2004. “Information Costs and Home Bias: An Analysis of US Holdings of Foreign Equities”. Journal of International Economics 62(2): 313–336.
Brad M. Barber and Terrance Odean. 2013. “The Behavior of Individual Investors”. In Handbook of the Economics of Finance, Vol. 2, Part B, Chap. 22, pp. 1533–1570. Elsevier B.V. https://doi.org/10.1016/B978-0-44-459406-8.00022-6.
Fischer Black and Robert Litterman. 1992. “Global Portfolio Optimization”. Financial Analysts Journal 48(5): 28–43. https://doi.org/10.2469/faj.v48.n5.28.
Jean L. Brunel. 2011. “Goal-Based Wealth Management in Practice”. The Journal of Wealth Management 14(3): 17–26. https://doi.org/10.3905/jwm.2011.14.3.017.
Charles Schwab & Co. Inc. 2020. Goal Tracker for Schwab Intelligent Portfolios. Last Accessed: March 20, 2020. https://intelligent.schwab.com/public/intelligent/insights/whitepapers/goal.html.
Charles Schwab & Co. Inc. 2016. How Savings “Buckets” Can Help You Reach Your Goals. Last Accessed: March 20, 2020. https://intelligent.schwab.com/public/intelligent/insights/blog/savings-buckets.html.
Charles Schwab & Co., Inc. 2019. Schwab Intelligent Portfolios Solutions, Disclosure Brochure. Last Accessed: September 29, 2019. https://www.schwab.com/public/file/CMS-BDL100049.
Ashvin B. Chhabra. 2005. “Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors”. The Journal of Wealth Management 7(4): 8–34.
Darwin Choi and Dong Lou. 2010. “A Test of the Self-Serving Attribution Bias: Evidence from Mutual Funds”. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1100786.
Joshua D. Coval and Tobias J. Moskowitz. 1999. “Home Bias at Home: Local Equity Preference in Domestic Portfolios”. The Journal of Finance 54(6): 2045–2073. 10.1111/0022-1082.00181.
Sanjiv Das, Harry Markowitz, Jonathan Scheid, and Meir Statman. 2010. “Portfolio Optimization with Mental Accounts”. Journal of Financial and Quantitative Analysis 45(2): 311–334.
Deutsches Aktieninstitut. 2020. Return Triangles. Last Accessed: March 20, 2020. https://www.dai.de/en/what-we-offer/studies-and-statistics/return-triangles.html.
Daniel Dorn and Gur Huberman. 2005. “Talk and Action: What Individual Investors Say and What They Do”. Review of Finance 9(4): 437–481.
Dan Egan. 2019. Using Investment Goals at Betterment. Last Accessed: March 20, 2020. https://www.betterment.com/resources/goals-advice-explained/.
Eugene F. Fama and Kenneth R. French. 1992. “The Cross-Section of Expected Stock Returns”. The Journal of Finance 47(2): 427–465. https://doi.org/10.2307/2329112.
Michael Fidora, Marcel Fratzscher, and Christian Thimann. 2007. “Home Bias in Global Bond and Equity Markets: The Role of Real Exchange Rate Volatility”. Journal of International Money and Finance 26(4): 631–655.
Baruch Fischhoff, Asher Koriat, and Sarah Lichtenstein. 1980. “Reasons For Confidence”. Journal of Experimental Psychology: Human Learning and Memory 6: 107–118. https://doi.org/10.1037/0278-7393.6.2.107.
Baruch Fischhoff, Paul Slovic, and Sarah Lichtenstein. 1977. “Knowing with Certainty: The Appropriateness of Extreme Confidence”. Journal of Experimental Psychology: Human Perception and Performance 3(4): 552–564. https://doi.org/10.1037/0096-1523.3.4.552.
Hisham Foad. 2011. “Familiarity Bias”. Behavioral Finance: Investors, Corporations, and Markets, Chap. 15, pp. 277–294. John Wiley & Sons, Ltd. https://doi.org/10.1002/9781118258415.ch15.
Kenneth R. French and James M. Poterba. 1991. “Investor Diversification and International Equity Markets”. American Economic Review 81(2): 222–226.
Markus Glaser and Martin Weber. 2007. “Overconfidence and Trading Volume”. The Geneva Risk and Insurance Review 32(1): 1–36. https://doi.org/10.1007/s10713-007-0003-3.
Adam Grealish. 2019. The Betterment Portfolio Strategy. Last Accessed: March 20, 2020. https://www.betterment.com/resources/betterment-portfolio-strategy/.
Mark Grinblatt and Matti Keloharju. 2009. “Sensation Seeking, Overconfidence, and Trading Activity”. Journal of Finance 64(2): 549–578. https://doi.org/10.1111/j.1540-6261.2009.01443.x.
Marcel Grzanna. 2018. Robos im Aufwind. Last Accessed: March 20, 2020. https://www.sueddeutsche.de/wirtschaft/robo-advisors-robos-im-aufwind-1.4197562.
Yuval N. Harari. 2015. Sapiens: A Brief History of Humankind. Vintage.
David Hirshleifer. 2015. “Behavioral Finance”. Annual Review of Financial Economics 7(1): 133–159. https://doi.org/10.1146/annurev-financial-092214-043752.
Daniel Kahneman and Amos Tversky. 1979. “Prospect Theory: An Analysis of Decision Under Risk”. Econometrica, Econometric Society 47(2): 263–291.
Karen K. Lewis. 1999. “Trying to Explain Home Bias in Equities and Consumption”. Journal of Economic Literature 37(2): 571–608.
Torben Lütje and Lukas Menkhoff. 2007. “What Drives Home Bias? Evidence from Fund Managers’ Views”. International Journal of Finance & Economics 12(1): 21–35. https://doi.org/10.1002/ijfe.309.
Don A. Moore and Derek Schatz. 2017. “The Three Faces of Overconfidence”. Social and Personality Psychology Compass 11(8). https://doi.org/10.1111/spc3.12331.
Nutmeg. 2020. How We Invest. Last Accessed: March 20, 2020. https://www.nutmeg.com/how-we-invest#portfolio-performance.
Carrie H. Pan and Meir Statman. 2012. “Questionnaires of Risk Tolerance, Regret, Overconfidence, and Other Investor Propensities”. SCU Leavey School of Business Research Paper, 10-05.
Shaun Port. 2013. An Inside View of the Nutmeg Investment Process: Asset Allocation. Last Accessed: March 20, 2020. https://www.nutmeg.com/nutmegonomics/an-inside-view-of-the-nutmeg-investment-process/.
Alexander Puetz and Stefan Ruenzi. 2011. “Overconfidence Among Professional Investors: Evidence from Mutual Fund Managers”. Journal of Business Finance & Accounting 38(5-6): 684–712. https://doi.org/10.1111/j.1468-5957.2010.02237.x.
Chad Rixse. 2018. The 4 Advantages of Human vs. Robo-Advisors. Last Accessed: March 20, 2020. https://www.cnbc.com/2018/4/25/the-4-advantages-of-human-vs-robo-advisors.html.
Scalable Capital. 2018. Scalable Capital gewinnt Openbank die Digitalbank der Santander- Gruppe, als Partner in Spanien. Last Accessed: March 20, 2020. https://de.scalable.capital/presse/scalable-capital-gewinnt-openbank.
Mark S. Seasholes and Ning Zhu. 2010. “Individual Investors and Local Bias”. Journal of Finance 65(5): 1987–2010.
Hersh Shefrin. 2000. Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing. Harvard Business School Press.
Paul Slovic, Baruch Fischhoff, and Sarah Lichtenstein. 1981. “Facts and Fears: Societal Perception of Risk”. Advances in Consumer Research 8: 497–502. http://www.acrwebsite.org/search/view-conference-proceedings.aspx?Id=5844.
Christin Stock and Joachim Goldberg. 2013. Genial Einfach Entscheiden: Besser Denken, Handeln und Investieren im Täglichen Entscheidungsdschungel. FinanzBuch Verlag.
Ola Svenson. 1981. “Are We All Less Risky and More Skillful than our Fellow Drivers?” Acta Psychologica 47(2): 143–148. https://doi.org/10.1016/0001-6918(81)90005-6.
Nassim Taleb. 2007. The Black Swan: The Impact of the Highly Improbable. Random House Group.
Michael Tertilt and Peter Scholz. 2018. “To Advise, or Not to Advise— How Robo- Advisors Evaluate the Risk Preferences of Private Investors”. The Journal of Wealth Management 21(2): 70–84.
Linda L. Tesar and Ingrid M. Werner. 1995. “Home Bias and High Turnover”. Journal of International Money and Finance 14(4): 467–492. https://doi.org/10.1016/02615606(95)00023-8.
Richard Thaler. 1985. “Mental Accounting and Consumer Choice”. Marketing Science 4(3): 199–214.
Richard Thaler. 1980. “Toward a Positive Theory of Consumer Choice”. Journal of Economic Behavior & Organization 1(1): 39–. https://doi.org/10.1016/0167-2681(80)90051-7.
Harish Thiagarajan. 2018. Testing the GPS Behind Tomorrow’s Self-Driving Money. Last Accessed: March 20, 2020. https://eng.wealthfront.com/2018/06/28/testing-the-gps-behind-tomorrows-self-driving-money/.
Amos Tversky and Daniel Kahneman. 1974. “Judgment under Uncertainty: Heuristics and Biases”. Science 185(4157): 1124–1131. https://doi.org/10.1126/science.185.4157.1124.
Amos Tversky and Daniel Kahneman. 1981. “The Framing of Decisions and the Psychology of Choice”. Science 211: 453–458. https://doi.org/10.1126/science.7455683.
Vanguard. 2020. Introducing Vanguard Personal Advisor Services. Last Accessed: March 20, 2020. https://investor.vanguard.com/financial-advisor/personal-advisor-services.
Vanguard. 2020. Investing Goals. Last Accessed: March 20, 2020. https://investor.vanguard.com/investing/goals.
Vanguard. 2020. Vanguard Personal Advisor Services. Filmed October 14 2015 at Youtube. Video 1:52. https://www.youtube.com/watch?v=OYgJhCoAUnA.
Vanguard Advisers, Inc. 2019. Vanguard Personal Advisor Services Brochure. Last Accessed: September 29, 2019. https://personal.vanguard.com/pdf/vpabroc.pdf.
Wealthfront. 2020. Investing Isn’t an Art. It’s a Science. Last Accessed: March 20, 2020. https://www.wealthfront.com/investing.
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2021 The Author(s)
About this chapter
Cite this chapter
Scholz, P., Grossmann, D., Goldberg, J. (2021). Robo Economicus? The Impact of Behavioral Biases on Robo-Advisory. In: Scholz, P. (eds) Robo-Advisory. Palgrave Studies in Financial Services Technology. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-40818-3_4
Download citation
DOI: https://doi.org/10.1007/978-3-030-40818-3_4
Published:
Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-030-40817-6
Online ISBN: 978-3-030-40818-3
eBook Packages: Economics and FinanceEconomics and Finance (R0)