Behavioural Finance Course Outline

Indian Institute of Management, Kozhikode

July-August 2021

Course Name: Behavioral Finance

Credits: 30 Hours

Course Instructor: Dr. Kavitha Ranganathan

Part 1
1. INTRODUCTION

Behavioral Finance as an emerging field in finance, is the study of how psychology affects financial
decision-making process and financial markets (Shefrin, 2001). This field came into prominence in the
early part of 1990s when number of researchers documented that contrary to the efficient markets
hypothesis, anomalies could be observed in asset prices and markets. This came to be known as macro
behavioral finance. In the later years, researchers started to analyze behavior of individual investors and
managers, that questions the assumptions of rational decision-making process. The study of individual
decision-making affecting financial markets and prices, came to be known as micro behavioral finance. It
is also known that the field of behavioral finance has been influenced by various schools of thought. For
example, the popular research program on “Heuristics and Biases” by Kahneman and Tversky (1979,
1992) is predominantly based on documenting irrational or sub-optimal behavior that are
counterproductive for an individual’s economic welfare. In contrast, there is the framework of bounded
rationality and study of “Fast and Frugal Heuristics” as adaptive tool-box that individuals use to deal with
uncertainty, and not because human beings are prone to make irrational decisions (Gigerenzer, 2008).

This Behavioural Finance course attempts to cover aspects of macro and micro behavioral finance. We
begin with exploring the building blocks or theoretical models that led to the creation of behavioral finance
as a field, such as, expected utility, bounded rationality, prospect theory and decisions from experience.
Then, we apply the insights from behavioral finance across various fields in finance, such as, Asset
Pricing, Corporate Finance, Portfolio Theory and Wealth Management, Mergers and Acquisitions,
Individual Investor Behavior, and finally Regulation and Public Policy. The point is, with evidence from
empirical and experimental research in behavioral finance, we try to answer the question, ‘‘why people
and markets behave the way they do’.
2. COURSE OBJECTIVES
This course examines how the insights of behavioral finance complements or questions the traditional
paradigm of finance and sheds light on the behavior of asset prices, firm and investor behavior.

COURSE LEARNING OUTCOMES (CLO):

Upon completion of this course, students should:
CLO 1: Critically evaluate underlying theories, assumptions, limitations and arguments in classical and
behavioral finance
CLO 2: Understand the application of behavioral finance to specific areas of Finance, i.e. asset pricing,
corporate finance, portfolio and wealth management, mergers and acquisitions, investor behavior,
and public policy and regulation
CLO 3: Critically evaluate strengths and weaknesses in field of behavioral finance and implications for
researchers/practitioners

3. COURSE CONTENT:
 Foundations of Behavioral Finance:
o Expected Utility and Bounded Rationality Theory
o Prospect Theory
o Decisions from Experience
 Market Inefficiency and Asset Pricing:
o Market anomalies and limits to arbitrage.
 Behavioral Corporate Finance:
o Rational managers and irrational investors approach, irrational managers and rational investors
approach, managerial actions taking advantage of mispricing and impact on firm’s corporate
finance decisions.
 Mergers and Acquisitions:
o Offer Premium, 52-week anchoring effect in M&A, Winner’s Curse and Negotiations
 Portfolio Theory and Wealth Management:
o Behavioral Portfolios, Michael Pompian: Adapt vs Moderate framework
 Individual Investor Behavior
o Fast and Frugal Heuristics, Behavioral Biases, Emotional vs Cognitive Biases
 Regulation and Public Policy
o Nudge vs Boost
4. PEDAGOGY
The classes will consist of lectures, experiments, discussions, problem-solving and case analyses.

5. ASSESSMENT SCHEME AND WEIGHTAGE

Evaluation Weightage (%) Duration (Mins) CLO Tested

End Term Exam 50% 90 mins CLO 1
Presentation (at the end of
course) and Class 30% 20 mins per group CLO 3
Participation
Take Home
Project Submission 20%
Assignment CLO2

TASK 1 – Presentation and Class Participation

Weightage: 30%

Students are required to make a presentation of a particular article. The topics of interest can be chosen
from various sub-topics outlined in various sessions, for ex: Asset Pricing, Behavioral Portfolios,
Behavioral Corporate Finance, Mergers and Acquisitions, Portfolio Theory, Investor Behavior, and
Regulation.

Marks will be allocated to students on the basis of their actual participation in class, not for just attendance.
Marks for participation will be based on the regularity and appropriateness of your participation. Note that
the consistency and quality of your participation is therefore very important. You will be assessed on the
extent to which you demonstrate that you have completed the assigned reading prior to attending class
together with your ability to demonstrate that you have thought through the topic and the issues associated
with it. To obtain a good grade, you must actively and constructively participate in classroom discussions.

TASK 2 – Project

Weightage: 20%

Students can choose a question for research among those below. One could answer these questions using
survey methodology or secondary data collection or case analysis or documenting anecdotal evidences. In
fact, if you are curious about a topic in behavioral finance, and want to add that to the list, pls do ahead!

1. What kind of simple heuristics (bounded rational decisions) do Corporate follow? Use anecdotal
evidences and real-world examples.
2. Prospect Theory applications in Financial Decision-Making. Real-world examples from corporations.
3. Real-world cases of the Description-Experience Gap. Literature Review and Anecdotal Evidences.
4. Document some of the Market Anomalies using secondary data, i.e. Calendar effect, Size Effect,
Momentum Effect, etc.
5. Risk Profiling of Investors. Use case study method.
6. Constructing Behavioral Portfolios. Use case study method.
7. Document investor biases using Survey Method.
8. Risk Literacy: Document cases of risk illiteracy among investment professionals.
9. Real world examples of Nudging versus Boosting.
 PART 2: SESSION PLAN

I believe in “less is more”, so you will find a list of readings for the class (column A), just minimally kept to one
paper. I hope you can do this reading before every class! In column B, you will find a list of papers that are
mapped according to the respective topic and part of recent literature.

You will have to select a topic for your presentation, and for the project (the topic could be the same or different
for both).

Session Topic Pedagogy A. Session B. Additional Tentative

Readings for Readings Dates
the Class

1 Traditional vs Lecture and Come with a - 03-July

Behavioural what to expect. curious mind!
Perspectives

2 Traditional vs Lecture and a Cashews, Coffee Baltussen, G. (2009). 03-July

Behavioural Survey Mugs, and the Birth Behavioral finance: An
Perspectives of Behavioral introduction. Available
Economics at SSRN 1488110.

HBR Case Study

(IIMK to procure).

3 Bounded Lecture Gigerenzer, G. Mousavi, S., & 04-July

Rationality (2018). The Gigerenzer, G. (2014).
heuristics Risk, uncertainty, and
revolution: heuristics. Journal of
Rethinking the role Business
of uncertainty in Research, 67(8), 1671-
finance. In The 1678.
Behavioural
Finance Revolution.
Edward Elgar
Publishing.

4 Simple Experiment and Gigerenzer, G. Berg, N., Prakhya, S., 04-July

Heuristics in Discussion (2018). The & Ranganathan, K.
Finance (Satisficing heuristics (2018). A satisficing
Experiment) revolution: approach to eliciting
Rethinking the role risk preferences.
of uncertainty in
 finance. In The Journal of Business
Behavioural Research, 82, 127-140.
Finance Revolution.
Edward Elgar
Publishing.

5 Prospect Theory Lecture Prospect Theory in Kahneman, D., & 17-July

Action: Tversky, A. (1979).
Prospect theory: An
analysis of decision
https://medium.com
under
/strategy- risk. Econometrica:
dynamics/prospect- Journal of the
theory- Econometric Society,
37eaa1e250bb 263-291.

6 Prospect Theory Lecture Altman, M. (2010). https://www.mckinsey. 17-July

Applications in Prospect theory and com/business-
Finance behavioral functions/strategy-and-
finance. Behavioral
corporate-finance/our-
Finance: Investors,
Corporations, and insights/overcoming-a-
Markets, 191-209. bias-against-risk#

7 Disposition Lecture Shefrin, H. (2007). https://www.businessto 18-July

Effect How the disposition day.in/moneytoday/inv
effect and estment/disposition-
momentum impact
effect/story/10485.html
investment
professionals. Journ
al of Investment
Consulting, 8(2),
68-79.

8 Behavioral Debriefing the Instructor’s Survey - 18-July

Decisions Survey on Behavioral
Decisions.
9 Decisions from Experiment Hertwig, R., & Kaufmann, C., Weber, 24-July
Experience (DFE Erev, I. (2009). The M., & Haisley, E.
Investment description– (2013). The role of
experience gap in
Experiment) experience sampling
risky choice. Trends
in cognitive and graphical displays
sciences, 13(12), on one's investment
517-523. risk
appetite. Management
science, 59(2), 323-
340.
10 Decisions from Lecture Hertwig, R., & Kaufmann, C., Weber, 24-July
Experience Erev, I. (2009). The M., & Haisley, E.
description– (2013). The role of
experience gap in
experience sampling
risky choice. Trends
in cognitive and graphical displays
sciences, 13(12), on one's investment
517-523. risk
appetite. Management
science, 59(2), 323-
340.

11 Market Experiment in Ball, S. B., & Holt, - 25-July

Efficiency Class (Charles C. A. (1998).
Holt Asset Classroom games:
Speculation and
Bubble
bubbles in an asset
Experiment), market. Journal of
Economic
Perspectives, 12(1),
207-218.

12 Market Lecture and Shiller, R. J. (2003). Fama, E. F. (1998). 25-July

Inefficiency and Debriefing the From efficient Market efficiency,
Anomalies Experiment markets theory to long-term returns, and
behavioural finance. behavioral
Journal of economic finance1. Journal of
perspectives, 83- financial
104. economics, 49(3), 283-
306.

13 Behavioral Lecture Shefrin, H., & https://retirementincom 01-Aug

Portfolio theory Statman, M. (2000). ejournal.com/article/the
Behavioural -case-for-behavioral-
portfolio portfolio-theory/
theory. Journal of
financial and
quantitative
analysis, 35(02),
127-151.

14 Behavioral Lecture Asset Allocation for The use of behavioral 01-Aug

Wealth Real-World finance in the wealth
Management Investors. management process
Incorporating
Behavioral Finance
 into Your Practice, https://www.econstor.e
Michael Pompian. u/bitstream/10419/6676
4/1/68885026X.pdf

15 Behavioral Lecture Shefrin, H. (2001). Malmendier, U. 07-Aug

Corporate Behavioural (2018). Behavioral
Finance corporate Corporate
Theories finance. Journal of Finance (No. w25162).
Applied Corporate National Bureau of
Finance, 14(3), 113- Economic Research.
126.

16 IPO Lecture Ritter, J. R. (2003). http://aswathdamodara 07-Aug

Underpricing— Behavioral n.blogspot.com/2019/1
Behavioral finance. Pacific- 0/ipo-lessons-for-
Explanations Basin finance public-market-
journal, 11(4), 429- investors.html
437.

17 Valuation Bias Lecture Hersh Shefrin https://www.forbes.co 08-Aug

among Sell-side (2018), Valuation m/sites/hershshefrin/20
Equity Analysts. Bias and Limits to 20/04/10/great-
Nudges, Working depression-economics-
Paper. 101-keynes-take-on-
the-stock-
https://jpm.pm- market/?sh=6e4476db5
research.com/conten d4d
t/45/5/112.abstract

18 Anchoring in Lecture Ranganathan, K., & https://www2.deloitte.c 08-Aug

Mergers and Singh, P. (2021). om/content/dam/Deloitt
Acquisitions Anchoring in e/de/Documents/financ
Mergers and e-
Acquisitions: Does transformation/CFO_In
the Regulatory sights_Whats-the-right-
Environment price.pdf
Matter?. Journal of
 Accounting,
Auditing &
Finance, 36(1), 142-
171.

19 Individual Lecture https://morningstari https://www.researchga 14-Aug

Investor Biases nvestments.com.au/ te.net/publication/2800
wp- 87380_How_Biases_A
content/uploads/201 ffect_Investor_Behavio
7/03/Session-5- ur
Simply-Human-
Your-Toolkit.pdf

20 Individual Lecture https://morningstari https://www.researchga 14-Aug

Investor Biases nvestments.com.au/ te.net/publication/2800
wp- 87380_How_Biases_A
content/uploads/201 ffect_Investor_Behavio
7/03/Session-5- ur
Simply-Human-
Your-Toolkit.pdf

21 Risk Literacy Lecture and https://www.youtub https://www.entreprene 22-Aug

Survey e.com/watch?v=g4o ur.com/article/354687
p2WNc1e4

22 Risk Literacy Debriefing the -- -- 22-Aug

Survey

23 Regulation and Nudging and Grüne-Yanoff, T., Hertwig, R., & Ryall, 28-Aug
Public Policy-- Boosting & Hertwig, R. M. D. (2016). Nudge
Nudging (2016). Nudge vs. Boost: Agency
versus boost: How Dynamics Under
coherent are policy 'Libertarian
and theory? Minds Paternalism'.
and Machines, 26(1-
2), 149-183.
 24 Regulation and Debate: Nudging -- Ly, K., Mazar, N., 28-Aug
Public Policy-- versus Boosting Zhao, M., &
Boosting Soman, D. (2013).
A practitioner's
guide to nudging.

25 Review Session Putting -- -- 29-Aug

everything
together

26 Presentations Group -- -- 29-Aug

Presentations

27 Presentations Group -- -- 29-Aug

Presentations

I. Some Recommended Books

(Behavioral Finance is an emerging field. Although, the textbook offered for this course is Ackert and
Deaves, I would prefer you to read from the vast literature spanning from research papers to popular
press, that are cited in the Readings section).

Lucy F Ackert and Richard Deaves (2011), Understanding Behavioral Finance, South-Western, (Cengage
Learning), 1st/e.

Hersh Shefrin (2006), Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of
Investing, Oxford University Press.

Lars Tvede (2002), The Psychology of Finance: Understanding the Behavioral Dynamics of Markets, John Wiley
& Sons.

J Fox (2009), The Myth of Rational Market: A History of Risk, Reward and Delusion on Wall Street, Harper
Business.

James Montier (2007), Behavioral Investing: A Practitioners Guide to Applying Behavioral Finance, John Wily &
Sons.

Shiller, R. J. (2015). Irrational exuberance. Princeton university press.