Ch9_Kim_BKM_INV_7th - Bodie Kane Marcus Essentials of Investments Chapter 9 Behavioral Finance and Technical Analysis Bodie Kane Marcus Essentials

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Essentials of Investments Bodie • Kane • Marcus Chapter 9 Behavioral Finance and Technical Analysis
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Essentials of Investments Bodie • Kane • Marcus Premise: Conventional finance ignores how real people makes decisions and people make a difference Interpret the anomalies as consistent with several “irrationalities” that seem to characterize individuals make complicated decisions. Investors do not always process information correctly, and thus infer incorrect probability distribution about future returns. Even given a probability distribution of returns, investors often make inconsistent or systematically suboptimal decisions. Behavioral finance is still in its infancy Its critique of full rationality in investor decision making is well taken, but the extent to which limited rationality affects asset pricing is controversial. Behavioral Critique
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Essentials of Investments Bodie • Kane • Marcus Information Processing Errors in information processing can lead investors to misestimate the true probabilities of possible events or associated returns. Forecasting errors: Give too much weight to recent experience, and make forecasts that are too extreme given the uncertainty inherent in information Overreaction and correction Overconfidence: Overestimate abilities and the precision of beliefs or forecasts Dominance of active management, More active trading by men, Poor performance by active trading Sample size neglect: Generalize too much based on the result from a small sample Infer a pattern too quickly based on a small sample and extrapolate apparent trends too far into the future Overreaction and correction Behavioral Critique
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Essentials of Investments Bodie • Kane • Marcus Information Processing Conservatism: Too slow to update beliefs in response to new evidence Underreaction and correction Behavioral Biases Even if information processing were perfect, individuals tend to make less-than-fully rational decisions using that information. Framing: Decisions seem to be affected by how choices are framed: Reject a bet when it is posed in terms of risk associated with possible gains, and accept the same bet when it is described in terms of risk associated with potential losses Mental accounting: People segregate certain decisions: Ignore the portfolio approach Take a very risky position with one investment, but a very conservative position with another investment Behavioral Critique
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Essentials of Investments Bodie • Kane • Marcus Behavioral Biases Regret avoidance: More regret with badly turned-out decision when the decision was more unconventional More regret with the loss from the investment in an unknown start-up firm Prospect theory: Investor utility function depends on gains or losses from starting position, rather than on levels of wealth Loss aversion Limits to Arbitrage Behavioral biases would not matter for pricing if rational
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This note was uploaded on 12/13/2011 for the course MANAGEMENT 103 taught by Professor Mr.singh during the Spring '11 term at Aristotle University of Thessaloniki.

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Ch9_Kim_BKM_INV_7th - Bodie Kane Marcus Essentials of Investments Chapter 9 Behavioral Finance and Technical Analysis Bodie Kane Marcus Essentials

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