Week7 - Behavioural Finance

• what two components are involved in rational behaviour

  i. beliefs

  ii. actions
• what are most biases and deviations from rationality caused by

  emotions rather than cognitive limitations hence even when we are aware of bias it may still be hard to avoid them
• what does arbitrage require

  arbitrage is usually limited in the sense that looking for arbitrage opportunities is costly and often requires hedging - its often impossible to find the right stock that will do perfect hedging
• what is the evidence for limited arbitrage

  when a stock enters the NASDAQ index its value appreciates by 3.5% on average in the same trading day and most of this increase survives in the long-run
• what are the two main causes of limited rationality at the level of beliefs

  i. incorrect internalisation of information

  ii. weak probabilistic intuition
• what probabilities do we give to events which are salient, and close in time and space

  we give more weight to events which are recent in time and closer in space and also to those events which are salient
• what is the evidence towards stiffness of beliefs

  after we are endowed with a certain belief, it is hard to change them - we tend to be against seeking more evidence. we also tend to underestimate the new evidence which speaks against our beliefs and interpret it wrongly so it can support our beliefs
• what do people with depression tend to do regarding wishful thinking and overconfidence

  they are better able to assess the likelihood of negative and positive events
• what do people tend to think about gains and losses

  people would portray a loss of £1000 much worse than its gain
• what characteristics does regret have

  i. its an evolutionary mechanism for learning and internalising mistakes

  ii. regret due to an action that caused us loss is greater than regret towards a similar loss due to failing to act

  iii. regret from a mistake shared by a group is less severe

  iv. regret is greater the closer we were to doing the right thing
• what is mental discounting

  preferring 99p today rather £1 tomorrow
• explain the demand effect

  the tendency to respond to questionnaires insincerely to avoid embarrassment. participants will assess what the researcher is expecting as an answer or what the correct answer is.
• why are questionnaires worse than games

  games allow us to avoid questions and focus on what the agent does rather than what they say