New tools which combine game and economic theory can reveal a client’s “economic fingerprint” of investment behaviour, better enabling advisers to tailor advice, delegates heard at PortfolioConstruction’s Finology Summit.
Contrary to conventional wisdom, financial sophistication is not measured by whether a client knows what a stock or a bond is, but whether they have the ability to express preferences in a coherent and ordered set of decisions, argued Dr Daniel Silverman, Rondthaler Professor of Economics at Arizona State University, and senior research adviser to Capital Preferences.
“From my perspective the tools there are very much underdeveloped and much less mature. There is a spectacular gap between the sophistication of tools for guiding clients to higher returns for lower risk versus these tools for providing tailored results,” Silverman said.
He adds a central challenge for advisers is that a client can have a very difficult time verbally expressing their preferences, and as a result an adviser cannot easily translate what a client says into advice for a portfolio.
“So our solution is to let people’s choices speak for themselves, by allowing people to communicate their preference through their actions rather than trying to explain verbally.”
New tools
That solution is facilitated by new tools that build on classic economic theory, then lever game theory to facilitate the communication in a rapid way.
“It’s a remarkably quick and fun way to communicate how you trade off risk versus return, consumption now versus later, and consumption for yourself versus others.”
A series of games are offered which, based on some goals and some theory, allow for inferences to be made about a client’s true preferences, which in turn enables predictions to be made about their behaviour in the real world.
“What these methods do is combine economic theory with econometrics and mathematics to reveal what we are calling economic fingerprinting.
“The nice thing about using a scientific set of scores is that you can quantify these preferences with precision. In other words you will know if you have a strong handle on a client’s preferences for risk.”
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