G17 - Financial Forecasting and SimulationReturn

We argue that individuals systematically interpret sequences of events in a causal manner. The aim of this article is to show that people do so even if they are aware of the stochastic nature of the respective sequence. The bias can explain some anomalous behaviour of investors in financial markets. Small as well as professional investors may illusorily perceive causality of former random success and future yield. Laboratory experiments testing the interpretation of stochastically occurring events in financial designs as well as analyses of real trading data from financial markets confirm that investors indeed interpret (quasi)random events casually; they make incorrect predictions and they egocentrically allocate responsibility for their success. The causality illusion induces overconfidence, inefficient investment and risk seeking. In the conclusion, we discuss factors that may limit effects of the causality illusion and suggest future areas for research.

The article provides a basic description and taxonomy of sovereign wealth funds, rapidly gaining importance in the international monetary and financial systems. SFWs are pools of assets owned and managed directly or indirectly by governments to achieve specific objectives. Tentative estimates of foreign assets held by SWFs are between USD 1.9 trillion and USD 2.9 trillion. These amounts are about 10 times less than the assets under management of mature market institutional investors and modestly higher than those managed by hedge funds. Current IMF projections are that sovereign wealth funds will accumulate international assets under sovereign management up to about USD 12 trillion by 2012, but growth estimates are different. The author's estimate of the SWFs' growth by 2013 is between USD 3.9-5.4 trillion. These funds have raised concerns about financial stability, corporate governance and political interference and protectionism. The following analysis does not prove the negative distortions of these funds on global financial stability and capital flows. In response to these concerns, the IMF with SWFs have made public voluntary Generally Accepted Principles and Practices (GAPP) for SWF, and the OECD has published guidance on recepient country policies towards the SWFs. Recipient countries should strive to avoid protectionism and should uphold fair and transparent investment frameworks.