City Research Online

Abstract

Purpose – The purpose of this paper is to analyse five biases in the valuation of financial investments using a mental time travel framework involving thought investments – with no objective time passing.

Design/methodology/approach – An investment’s initial value together with any periodic funding cash-flows are mentally projected forward (at an expected rate of return) to give the value at the investment horizon; and this projected value is mentally discounted back to the present. If there is a difference between the initial and present values, then this can imply a bias in valuation.

Findings – The study identifies (and gives examples of) five real-world valuation biases: biased funding cash-flow estimates (e.g., mega infrastructure projects); biased rate of return projections (e.g., market crises, tech stock carve-outs); biased discount rate estimates (e.g., dual-listed shares, dual-class shares, short-termism, time-risk misperception, and long-termism); time-duration misestimation or perception bias when projecting (e.g.,time-contracted projections which lead to short-termism); and time-duration misestimation or perception bias when discounting (e.g., time-extended discounting which also leads to short-termism). More than one bias can be operating at the same time and we give an example of low levels of retirement savings being the result of the biased discounting of biased projections. Finally, we consider the effects of the different biases of different agents operating simultaneously.

Originality/value – The paper examines key systematic misestimation and psychological biases underlying financial investment valuation pricing anomalies

Publication Type:	Article
Additional Information:	© Copyright the authors. This AAM is provided for your own personal use only. It may not be used for resale, reprinting, systematic distribution, emailing, or for any other commercial purpose without the permission of the publisher.
Publisher Keywords:	financial investment valuation; thought investment; mental time travel; rational and irrational expectations; projecting; discounting; biases; heterogeneous agents.
Subjects:	H Social Sciences > HG Finance
Departments:	Bayes Business School Bayes Business School > Finance
SWORD Depositor:	Symplectic Administrator

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