Some time ago, I sat down with Greg Davies, who is Head of Behavioural Science at Oxford Risk, and founder of Centapse. During the conversation, we discussed why it’s important to have a framework for making financial decisions. Over the next few posts, I want to share the main points of that interview with you.
What is behavioural finance?
Greg's work combines techniques from classical quantitative finance – traditional things like escrow trade-offs, portfolio analytics and theory – with the relatively new field of behavioural finance, which is understanding the psychology of how and why people make decisions and where they may make decisions which are not in their financial interest even though they may be emotionally comfortable.
Greg started in the more traditional field of economics from an academic perspective, and worked for several years as a management consultant before returning to academia.
He was intending to study for a PhD in philosophy, looking at the philosophy of rationality, which underpins economic theory, and came across behavioural finance, which considered many of the same questions but in a more empirical way.
Behavioural finance uses psychology investigation and studies from that field to look at how people make decisions in reality, rather than simply speculating in a hypothetical way about how a rational person might do it.
This led to an accidental career choice because at the time Behavioural Economics was still unknown even in academia – Greg describes himself as being considered the ‘lunatic fringe’ of the Economics faculty!
Behavioural Finance goes mainstream
However, about a year after he started, Daniel Kahneman won the Nobel Prize for Economics “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.” Kahneman's work has been instrumental in creating a synthesis between psychological theory and our understanding of people with economic and financial behaviour.
Greg explained: “All economic behaviour is ultimately driven by human decisions, and unless we understand those we can’t claim to understand the functioning financial markets or to help people make better decisions. This is because the only tool we have is what the theory tells us you would do if you were perfectly rational all the time, which is not very helpful. Behavioural economics and finance allows us to offer much more practical and real advice to people”.
A new career path
While studying for his PhD, Greg also set up a small consultancy which was taking these ideas out of academia and into the financial world. After a few years, he was approached by Barclays, who’d been reading up on the field of behavioural economics and wanted him to lead a new team of people operating in the field.
This fell into Greg’s sweet spot of taking his academic knowledge and making a career out of something he found fascinating. The team was built over eight years, and in that time behavioural finance and behavioural economics has gone from strength to strength.
I asked Greg if he thought it was possible to define behavioural finance in one sentence? He said it’s difficult to do that, because if you spoke to five different people working in the field they would give five different answers, but for him:
“Behavioural finance is essentially how we combine an understanding of practical human decision-making with finance theory in order to forge a better understanding of economic behaviour and markets, but also to help people to make better decisions as a result.”
Many in the academic world are not interested in the last part of Greg’s definition, focusing instead on behaviours, but his team utilises the information to improve behaviour. He feels that’s important when making behavioural finance a commercial practice.
Read part two, here