B.7 Behavioral Finance (1).pptx

B.7 Behavioral Finance (1).pptx - • Conventional vs...

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Conventional vs. behavioral finance Behavioral finance Bounded rationality Behavioral biases Why do mis-pricings persist?: Limits to arbitrage Palm Computing Technical analysis: Is there a behavioral basis? Anomalies: Is there a behavioral basis? Outline: Behavioral Finance Venti Behavioral Finance 1
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Venti Behavioral Finance 2 Behavioral Finance What is a security worth? Intrinsic value What someone will pay you for it These two “values’ may differ
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Venti Behavioral Finance 3 Behavioral Finance If we always behaved rationally… Nobody would ever sell stocks in a panic at the first sign of trouble Nobody would ever buy stocks (or other investments) based on hunches, hot tips or media hype Nobody would overestimate their own ability Nobody would overweight recent information Nobody would make portfolio changes in response to irrelevant information Nobody would hang on to portfolio losers longer than they should.
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Behavioral Finance Conventional Finance Investors are rational and utility-maximizing Arbitrageurs make sure prices are in line with intrinsic values Prices reflect all available information Behavioral Finance Investors may be financially irrational and make financially suboptimal decisions Substantial barriers to arbitrage may exist Prices may not reflect all available information Venti Behavioral Finance 4
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Two main components of the behavioral critique: 1. Bounded Rationality : Investors do not always process information correctly. They have limited time and capacity to evaluate costs and benefits, and they make predictable (and avoidable!) mistakes. 2. Behavioral Biases: Even when calculations are correct, investors may make inconsistent or financially suboptimal decisions because….. they are human. Next: Some experimental evidence. The Behavioral Critique Venti Behavioral Finance 5
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One hundred Harvard students were asked: “A baseball and bat together cost $11. The bat costs $10 more than the ball. How much does the ball cost?” Fifty of the 100 students answered….$1. Ouch! Venti Behavioral Finance 6 Bounded Rationality
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Bounded Rationality Venti Behavioral Finance 7 Are most people capable of making financial decisions? Are they financially literate ? https :// World-wide, only 1/3 of all adults “passed” (4 of 5 correct). Only about 55% of all adult American adults passed! Overconfident or just clueless? Only 7% of the same respondents disagreed with the statement: “I am good at dealing with day-to-day financial matters, such as checking accounts, credit and debit cards, and tracking expenses.”
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Which line is longer?
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