Two News Report & Summary

Behavioral Finance and Technical Analysis

9

Bodie, Kane, and Marcus

Essentials of Investments, 9th Edition

McGraw-Hill/Irwin

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

9.1 Behavioral Critique

Behavioral Finance

Financial market model emphasizing potential implications of psychological factors affecting investor behavior

Existence of irrational investors is not sufficient to render capital markets inefficient

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9.1 Behavioral Finance

Information Processing

Forecasting errors

People overvalue recent experience compared to prior belief when forecasting

Overconfidence

People overestimate precision of beliefs or forecasts, and overestimate abilities

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9.1 Behavioral Finance

Information Processing

Conservatism bias

Investors too slow in updating beliefs in response to recent evidence

Sample size neglect and representativeness

People prone to believe small sample is representative of population, infer patterns too quickly

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9.1 Behavioral Finance

Behavioral Biases

Framing

Decisions affected by how choices are posed, i.e. gains relative to low baseline level or losses relative to higher baseline

Mental accounting

Form of framing; people segregate certain decisions

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9.1 Behavioral Finance

Behavioral Biases

Regret avoidance

People blame themselves for unconventional choices that turn out badly, avoid regret by making conventional decisions

Prospect theory

Investor utility depends on gains/losses from starting position, rather than levels of wealth

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9.1 Behavioral Critique

Limits to Arbitrage

Fundamental risk

Market changes or irrationality can eliminate profits

Implementation costs

Exploiting overpricing is difficult; costs and time limits can eliminate profits

Model risk

Inaccurate models generate inaccurate stock values

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Figure 9.1A Conventional Utility Function