Behavioral finance
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Behavioral Finance. Economics 437. Course Information. Three Books Andre Shleifer – “Inefficient Markets” Daniel Kahneman – “Thinking: Fast and Slow Edwin Burton – Sunit Shah – “Behavioral Finance” Online Reading at Toolkit Reading is difficult I-Clickers - required Lectures Exams

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Behavioral Finance

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Behavioral finance

Behavioral Finance

Economics 437


Course information

Course Information

  • Three Books

    • Andre Shleifer – “Inefficient Markets”

    • Daniel Kahneman – “Thinking: Fast and Slow

    • Edwin Burton – Sunit Shah – “Behavioral Finance”

  • Online Reading at Toolkit

  • Reading is difficult

  • I-Clickers - required

  • Lectures

  • Exams

    • Two mid terms

      • Feb 20 and April 1

      • Final May 1: 2PM

  • Office Hours 11-12: Tues, Wed, Thur at VNB office (not on grounds)


Course topics

Course Topics

  • Review of MPT & EMH

  • Limits to Arbitrage

  • Anomalies

  • Serial Correlation in Stock Returns


Immediate reading today jan 14

Immediate Reading (today, Jan 14)

  • Malkiel (online)

  • Shiller (online)

  • Shleifer (book, Ch 1)

  • Fama (online)


Reading starting jan 23 noise trading limits to arbitrage

Reading (starting Jan 23)“Noise Trading” – Limits to Arbitrage

  • Black on Toolkit

  • Shliefer on Toolkit

  • Kahneman, pp. 3-40

  • Burton & Shah, pp 1-51


The efficient market hypothesis emh

The Efficient Market Hypothesis(EMH)

  • Price captures all relevant information

  • Modern version based upon “No Arbitrage” assumption

  • Why do we care?

  • Implications

    • Only new information effects prices

    • Publicly known information has no value

    • Investors should “index”

    • Allocation efficiency


The milton friedman argument for market efficiency in the presence of noise traders

The Milton Friedman argument for market efficiency in the presence of “noise traders”

  • If noise traders are truly “random,” then their effects will “cancel out.” (Kind of a law of large numbers result)

  • Noise traders are “systematic,” then arbitrage traders will “trade against them” and take all of their money

  • Thus prices will be efficient in either case


But then

But, then

  • October 19, 1987

  • 1992, Article by Eugene Fama and Ken French

  • The Tech Bubble

  • The Rise of Hedge Funds


Behavioral finance

1987 - The “Rip Van Winkle” Year

2700

2300

2200

2200

2200

1700

Jan

July

October

Dec


Fama and french

Fama and French

  • Both authors are staunch supporters of EMH

  • 1992 Article gave a simple formula to pick stocks that “beat the market” consistently

  • This lead “respectability” to a growing literature that simple formulae could “beat the market”


The tech bubble

The Tech Bubble

  • 1999 Nasdaq up 100 percent for the year

  • Priceline:

    • Came public at 20, rose to 200, fell to under 1

    • No news of substance

  • Nasdaq peaked at 5000 in March 2000

  • Fell to 1800 by 2002


Hedge funds

Hedge Funds

  • Industry grew from cottage industry to massive industry

  • Charges very, very high fees to customers

  • Idea: they can outperform the market; thus they deserve the big fees

  • Used by Harvard and Yale endowments (UVA as well)


The efficient market hypothesis according to fama 1970

The Efficient Market Hypothesis (according to Fama 1970)

  • Three forms:

    • Weak

    • Semi-strong

    • Strong

  • Differ by what information is used

    • Weak – past stock prices and returns

    • Semi-strong – publicly known information

    • Strong – all information including private


Fama 1970 article

Fama 1970 Article

  • Random Walk

    • f(rj, t+1|Φt) = f(rj, t+1)

    • Where the density function ft is the same for all t

  • Special Case is the “Fair Game” model

    • E(pj, t+1|Φt) = [1 + E(rj, t+1|Φt)]pj,t

  • Sub-martingale

    • E(pj, t+1|Φt) ≥ pj,t or E(rj, t+1|Φt) ≥ 0


Fama s conclusions

Fama’s Conclusions

  • Weak form strongly supported by data

  • Semi-strong seems to be supported but

    • Some evidence of return correlation

  • Strong form contradicted by market maker study


And there things stood

And There Things Stood

  • In 1970


The end

The End


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