Ideas of Joseph de la Vega — The father of Behavioral Finance

By Akhilesh Shrotre on The Capital

The belief(at least mine until some time ago) that Behavioral Finance is a recently coined theory is only partly true. Even if the actual term was conceptualized recently, the essence can be traced way back in the seventeenth century in Confusion de Confusiones, the work of Joseph de la Vega. Also recognized as the father of Behavioral Finance, his work conforms, in a surprisingly similar way, to the recent research in the field of investor behavior. He gained his financial expertise from the fact that he was a merchant who started his activities in 1683.

Photo by Nicola Fioravanti on Unsplash

Joseph de la Vega’s style of writing was pretty oratorical. But the most striking part was his acceptance that a majority of people won’t understand his work and he was absolutely okay with it. I would like to present some of his thoughts, which intrigue me and I feel are valid even in today’s world.

1. He describes the businesses as one of the most mysterious affairs. Sometimes fair while the other times discriminatory.
2. The nature of businesses is very dynamic, and it is extremely difficult to gauge in which direction they are going, or they will go in the future.
3. He says the stock market is a game of chance. The one who cheats the most wins. It serves no social purpose, and its only goal is to earn money.
4. At the same, he also argues that there are a lot of winners in this game and who make their living out of this, implying that the winners have something special in them.
5. The behavior of investors is greatly linked to their overconfidence, which comes from following the actions (advice) of some of the most powerful people.
6. There are mainly three investor biases: herding, overconfidence, and regret aversion.
   Herding is when investors follow what are investors are doing overlooking the rationality behind it.
   Overconfidence bias takes its root from the fact the people tend to overestimate their skills and capabilities not necessarily backed by facts while making the investment decisions.
   Risk aversion is nothing but one’s fear of regretting having made bad decisions. Some people will regret and be unhappy no matter what the outcome.
7. Excessive trading, which partly comes from the overconfidence bias, does more harm than good. In Joseph de la Vega’s words -

I am of the opinion that one should trade little because my philosophers tell me that in order to increase your strength, you should not eat a lot but rather digest your food well.

8. Overreaction occurs when significantly high weightage is given to the recent news rather than the fundamentals. This lead to a sharp rise or a sharp decline in the asset prices with respect to its intrinsic value.

9. There is also the other way around to this, meaning Underreaction. Investors continue to be skeptics even after the fundamentals become strong due to their resistance to change their opinions.

10. Disposition effect, a phenomenon in which investors sell good stocks early and continue to hold bad stocks, is more common than imagined. Joseph de la Vega was of the opinion that it is always good to book some profits without waiting for all the profits.

As concluding thoughts, it is pretty clear that Joseph de la Vega was able to identify the investor behavior pattern that was supported by the researchers in recent times.

I also pen my thoughts on Life Money Musings. You can also connect with me on Twitter.

References:

1. https://psycnet.apa.org/record/2014-54045-008
2. https://www.gwern.net/docs/economics/1688-delavega-confusionofconfusions.pdf

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