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Using fear to guide smart investments
Date:6/30/2011

Tel Aviv Playing the stock market can be a risky game. And when the market behaves unpredictably, public fear can lead to erratic investment responses and market chaos.

But there is a way to make this fear work in your favor, say Prof. Eshel Ben-Jacob and Dr. Yoash Shapira of Tel Aviv University's Raymond and Beverly Sackler School of Physics and Astronomy. The team's recent research demonstrates that a smart stock market portfolio should not only take into account negative correlations on returns among the stocks, but also the dynamics of volatility. "It's a way to build a portfolio that takes fear and other cognitive investor responses into account," says Prof. Ben-Jacob.

Reported in AIP Advances, the journal of the American Institute of Physics, this is the first study that uses the prism of volatility to study the effect of human behavior on financial markets.

Drawing inspiration from neurons

As they investigated trends in market volatility over long periods of time, the researchers, with their doctoral student Dror Y. Kenett, were able to discover a certain method to the market's madness a pattern within the chaos.

Currently, Prof. Ben-Jacobs explains, market analysis assumes that occurrences within the market are random what happens one day is unrelated to what may happen the next. But this is unrealistic, he says. Any change in the market, from a declining index to a change in policy, informs the way people invest. They might not remember precisely what they reacted to, but the cognitive sensation of uncertainty will stay with them.

Like Prof. Ben-Jacobs' earlier research into similarities between the U.S. market and the epileptic brain, this research was also inspired by neuron networks. The firing of neurons in the brain, says Prof. Ben-Jacobs, might appear to be random, but when you measure variations of activity, a pattern emerges. The same can be said of stock market volat
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Contact: George Hunka
ghunka@aftau.org
212-742-9070
American Friends of Tel Aviv University
Source:Eurekalert  

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