I brought Eight Fat Swine Blog back, in part, to flesh out a comprehensive model of investor experience over the course of a bunch of posts and podcasts. In the coming weeks, I’ll lay out the model in detail and categorize related posts under the CTN Archive Here. All feedback is welcome on Twitter @ppearlman or via email at [email protected]
The Cognitive Theory of Noise (CTN) is a comprehensive prescriptive investor experience model. It integrates Cognitive Therapy (CT) from the field of clinical psychology with investor experience phenomena described in the behavioral finance (BF) literature.
Currently, there is no one comprehensive prescriptive behavioral finance model focusing on evidence based change processes for maladaptive investor experiences such as the disposition effect, cognitive conservatism and biases, overconfidence etc.
Also, there is no unified model of BF which defines and categorizes investor behavior phenomenon seamlessly across levels of abstraction from meta-theoretical to applied levels.
CT provides a suitable integrative framework for adaptive investor behavior change for four reasons. First, it offers an encompassing and descriptively rich theory of human functioning across multiple modes of experience. Second, it has proven to be a flexible container that assimilates profile patterns across a variety of maladaptations. Third, CT has developed an array of clinical techniques or change processes that have been empirically validated and that can be adapted to address maladaptive investor behaviors.
Fourth, because CT and BF are both cognitive social science models, they make an assimilative integration natural across levels of abstraction. They share common roots in the cognitive revolution and common assumptions about the nature of the world, human functioning and language.
Cognitive Therapy Model
CT is a theoretical and clinical treatment model originally developed by Aaron T. Beck in the 1970s as a result of his depression research. Over time, the CT model has proven empirically robust and applicable across an increasing variety of maladaptive experiences. It has been studied extensively by subsequent researchers and applied by thousands of clinicians over years across the globe.
The basic idea is that the way people think affects the way they behave and feel and that, by restructuring or reframing thinking, behavioral and emotional changes may occur.
Cognitions, behaviors and emotions interrelate in a complex manner and can be organized systematically. These organizations or profiles can then be categorized diagnostically. For example, depressives may exhibit negative or pessimistic cognitions, depressed emotions including sadness or agitation and behavioral patterns reflecting amotivation or anhedonia.
CT holds that systematic information processing biases are critical features of most mental disorders. For example, depressives tend to have negativity biases towards themselves, their experiences and the future, while those with anxiety disorders tend to exhibit biased thinking relating to internal or external appraisals of danger.
Incorporating CT into a prescriptive model of investor experience allows us to use techniques derived from the field of clinical psychology which have proven effective in promoting adaptive change.
Behavior change is often difficult even when it is in someone’s best interest to change.
People are mostly immune to even the best advice and there are complex causal factors seeded in evolution, biology and culture which make habits, addictions and the like resistant to change.
Imagine telling a severe depressive to “just snap out of it”. It will be futile.
CTN comes equipped with an array of change processes or therapeutic techniques including consciousness raising, imaginal and graded exposure, reframing, cognitive restructuring etc.
Social and Clinical Psychology
Here’s a quick note of clarification for readers who might not be aware of the distinction between Social and Clinical Psychology which are two distinct categories of study within a broader field.
Clinical psychologists focus primarily on mental illness in terms of theory, diagnostics and treatment. They are interested in psychopathology where the disorder significantly interferes with areas of functioning like social, emotional, work, family etc.
Social psychologists focus primarily on the way people think, feel and interact with each other and the world. Behavioral finance was originally an integration of social psychology and economics.
Despite the distinction and the tendency to work along separate tracks, both clinical and social psychology share common roots and do sometimes interface in important ways with data from one field informing the other.
Kahneman and Tversky are social psychologists who studied the way people think and make decisions.
Aaron Beck is a psychiatrist who pioneered the theory and treatment of multiple psychological disorders.
It is crucial to note that seminal works by both were published in the same year, 1979, and both were influenced by the cognitive revolution and information processing models.
There’s a lot to dig into here and I’m not really sure what the next post will be. Bigger picture though, the next several posts will likely address:
Noise – In a seminal paper, Fisher Black uses the term very broadly to represent anything that contributes to markets being inefficient. I distinguish between internal and external noise and incorporate them into the CTN.
Normative, Descriptive and Prescriptive Models – Prescriptive models have been neglected in behavioral finance.
Unified Theories – Ugh, what are they good for?
Cognitive Triad – Critical to CT
Cognitive Revolution – Blues and Roots yall 😉
CTN Theory – Contextualizing investor experiences within the context of CT theory. This is the highest level of abstraction and critical to lay out in some detail before getting to profiles and change processes.
CTN Profiles – Creating cognitive/behavioral/emotional profiles of a few of the basic investor experiences like disposition effect within the domain of losses and gains, cognitive conservatism, confirmation bias. This is a bunch of posts, really.
CTN Change Processes – How do we effectively derive adaptive investor behavior change?
Normal vs Abnormal Experience – In clinical psychology, maladaptive experience is abnormal. In behavioral finance, maladaptive behavior is normal. WTF?
Nudge – What role does configuring the environment in specific ways play in promoting adaptive behaviors play in CTN? What might be limitations?
Research Implications – How would we study CTN?
Ok, enough for now…