3531Week7W11 - Week 7 Behavioural Finance and the...

Info iconThis preview shows pages 1–8. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Week 7 Behavioural Finance and the Psychology of Investing
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
McGraw-Hill Ryerson Limited 2 Behavioral Finance Sooner or later, you are going to make an investment decision that winds up costing you a lot of money. Why is this going to happen? – You made a sound decision, but you are ―unlucky.‖ – You made a bad decision—one that could have been avoided. The beginning of investment wisdom: – Learn to recognize circumstances leading to poor decisions. – You will reduce the damage from investment blunders.
Background image of page 2
McGraw-Hill Ryerson Limited 3 Behavioral Finance Behavioral Finance The area of research that attempts to understand and explain how reasoning errors influence investor decisions and market prices. Much of behavioral finance research stems from the research in the area of cognitive psychology. Cognitive psychology : the study of how people (including investors) think, reason, and make decisions. – Reasoning errors are often called cognitive errors. Some people believe that cognitive (reasoning) errors made by investors will cause market inefficiencies.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 Economic Conditions that Lead to Market Efficiency 1) Investor rationality 2) Independent deviations from rationality 3) Arbitrage For a market to be inefficient , all three conditions must be absent. it must be that many, many investors make irrational investment decisions, and the collective irrationality of these investors leads to an overly optimistic or pessimistic market situation, and this situation cannot be corrected via arbitrage by rational, well- capitalized investors.
Background image of page 4
McGraw-Hill Ryerson Limited 5 Prospect Theory Prospect theory provides an alternative to classical, rational economic decision-making. The foundation of prospect theory: investors are much more distressed by prospective losses than they are happy about prospective gains. Researchers have found that a typical investor considers the pain of a $1 loss to be about twice as great as the pleasure received from the gain of $1. Also, researchers have found that investors respond in different ways to identical situations. The difference depends on whether the situation is presented in terms of losses or in terms of gains.
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
McGraw-Hill Ryerson Limited 6 Investor Behavior Consistent with Prospect Theory Predictions There are three major judgment errors consistent with the predictions of prospect theory. Frame Dependence Mental Accounting The House Money Effect
Background image of page 6
7 Frame Dependence If an investment problem is presented in two different ways, investors often make inconsistent choices. That is, how a problem is described, or framed, seems to matter to people. Some people believe that frames are transparent. Are
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 8
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 50

3531Week7W11 - Week 7 Behavioural Finance and the...

This preview shows document pages 1 - 8. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online