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1、Topic 10: Behavioral Finance,Traditional Finance,Markowitz, Fama and the rest of the boys Rational decisions and unbiased predictions Risk, return, covariance Semi strong market efficiency and portfolio theory M&M (1961) assumes investors “always prefer more wealth to less and are indifferent as to
2、whether a given increment to their wealth takes the form of cash payments or an increase in the market value of their holdings of shares”,What do we observe?,Should be low trading low volume? Trade on info low volatility? Growth/Value or Small/Large shouldnt matter? Dividends shouldnt matter Equity
3、premium of 7% is too high for risk Momentum shouldnt exist Positive news boosts depressed stocks more than “up” stocks IPOs underperform long term Addition to S&P 500 permanently increases $ Buffett is just a chance happening,Whats going on in the “real” world?,“Buy on the rumor, sell on the fact.”
4、“Buy the dips, sell the rallies” “Cut losses short, let profits run” “When in doubt, stay out” “Manage the risks and profits will take care of themselves” “The more certain the crowd is, the surer it is to be wrong”,Behavioralism,Along come Kahneman, Thaler, Schliefer, Odean, and pals in the 1990s K
5、ahneman had right idea in the 1970s Risk Fear Return Greed “Bounded rationality” event is too complex biases in heuristics Not always rational and can make predictable errors,Whats the diff?,Information = Investors food which determines activity and prices EM prices integrate all info quickly BF som
6、e info neglected and other exaggerated Noise trading uncorrelated with changes in fundmental/intrinsic value. EM just that, noise! nothing in aggregate BF may be biased See other differences play out in slides that follow,Behavioralism,Its 1896 and the “Dow” is at 40. Its 1998 and the “Dow” is at 91
7、81 What would it have been if dividends had been reinvested? 652,230 like folding the paper 100 times “Heuristics” enable dealing with many inputs “anchoring” take 9181 and add some Kahneman & Tversky (1979) Prospect Theory (psychology) Shleifer and Vishny (1997) limits to Arbitrage,Prospect Theory,
8、2,1,3,Prospect Theory Normal Distribution,The probability that yearly return will fall within +/- one std. dev. (20%)Is 68%,Shleifer and Vishny (1997) Limits to Arbitrage,Econs Law of One Price Finance assumes riskless and available arb Limits Fundamental risk arb fear price is right Noise trader ri
9、sk - Siamese twin stocks Margin calls Long Term Capital No good substitute to short or may be unshortable A lot of investors are precluded from it and still others dont want the risk Closed-End funds = individual investors Palm/3com,More evidence,Liquidity from on-line trading makes arb easier? IPO
10、underpricing? Mergers & Acquistitons are quite frequently bad overconfidence Lowest decile of stocks based on B/M earn less than risk free rate Dividends shouldnt matter?,Indicators & Influences,Overconfidence Pride/Regret Past history = Info? Mental Accounting Portfolio construction Representativen
11、ess Herding Emotions Self Control,#1 - Overconfidence,A little knowledge is a dangerous thing Excessive trading Excessive risk taking Portfolio losses Survey of 3000 new small business owners 2001 survey of individual investors Stock market return next twelve months = 10.3% Return on personal portfo
12、lio = 11.7 Success reinforces overconfidence, so more pronounced in bull markets “Biased self-attribution”,#2 Pride/Regret,Pride “Disposition effect” = reluctance to realize losses Remember prospect theory Sell winners too soon Ride the losers for too long Reference point Need not be purchase price
13、Regret if sell below previous high,#3 Past History = Info?,Buy high and sell low Sounds like a winner to me? More willing to take higher risk after gains than losses Gains “house money” overconfidence seek riskier Losses “snake bite” avoid good opportunities Big losses really in a hole try to break
14、even “Cognitive dissonance” seek to reduce pain with selective memory “Confirmation bias” side with opinions that support own perceptions,#4 Mental Accounting,Each decision, action, and outcome filed in separate folder Ignore time value of money “Sunk cost” effect with anchoring and reference points
15、 Covariance & portfolio theory even finance professors cant walk the walk Hold losers too long Sell winners too soon No consideration of interaction.,#5 Portfolio construction,Covariance and diversification hard b/c of mental accounting Decisions made at individual stock level Accumulate money Whats
16、 a good buy consider acquisition in isolation 401K plans Pensions funds, too,#6 Representativeness,History again and familiarity Stereotypes Mary is quiet, studious, and concerned with social issues. While an undergraduate at Berkeley, she majored in English literature and environmental studies. Given this information, indicate which of the following three cases is most probable? Mary is a Librar
