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Behavioral Finance

Behavioral Finance. Economics 437. Background News. NLRB rules that college athletes are employees and therefore can form a union Citigroup denied the right to issue a dividend increase because they failed a stress test. [Would you accept a gamble that offers]. Yes No.

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Background News • NLRB rules that college athletes are employees and therefore can form a union • Citigroup denied the right to issue a dividend increase because they failed a stress test

  3. [Would you accept a gamble that offers] • Yes • No 10 percent change to win $ 95 90 percent chance to lose $ 5

  4. Prospect Theory • “Prospect” means the same thing as a lottery • “Prospect Theory” is about loss aversion • Risk aversion for gains • Risk preference for losses • Loss function steeper than gain function • Inevitably implies “path dependence” – literature says “reference points”

  5. Prospect Theory – in a Graph Risk aversion Risk preferring Be careful: This interpretation assumes expected utility

  6. Example – Equity Premium Puzzle • Expected Utility Fails to Provide an Explanation (too much risk aversion) • Loss Aversion provides Simple Explanation • But, Jorion and Goetzmann on survivor bias

  7. [Would you pay $ 5?] • Yes • No 10 percent chance to win $ 100 90 percent chance of winning nothing

  8. How about this • Would you accept a gamble that offers: • 10 percent chance to win $ 95 • 90 percent chance to lose $ 5 • Would you pay $ 5 • 10 % chance to win $ 100 • 90 % chance to win nothing Absolutely no difference between these two choices

  9. Experienced Well Being versus Anticipated Well Being • Economics is about anticipations, not “after the fact” evaluations • These could be very different

  10. The Role of the Story • Kahnmena’s experience at La Traviata • Duration effect and peak-end rule

  11. Second Mid Term • Tuesday, April 1st, 2014 • Readings: • Kahneman – read the entire book • Burton, Shah: read pp. 81-143, Chapters 8-13 • Emphasis • Anomalies; especially framing, representation, endowment effect, status quo effect • Loss aversion • Prospect Theory • Nothing is ruled out

  12. The End

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