Investor Behavior and the

Financial Market
(투자자행동과 금융시장)
Course Introduction

Prof. Seungho Choi

Department of Finance
Hanyang University Business School
Contact information

§ 최승호 교수

§ 경영관 513호

§ seunghochoi@hanyang.ac.kr
Introduction to the Course
Introduction to the Course

§ In all introductory economics and finance courses, we assume

all humans (and therefore markets) behave RATIONALLY

§ But we have seen many cases where the rationality assumption

appears difficult to defend

§ Dot.Com Bubbles, Global Financial Crisis, Cryptocurrency Bubbles…

Theory doesn’t seem to match the facts, so what should we do?

→ Look closely into actual human behavior
Introduction to the Course

§ This course aims to reconcile theoretical insights with observed facts

§ Camerer and Loewenstein (2004, p. 3):

“Behavioral economics increases the explanatory power of economics
by providing it with realistic psychological foundations”

§ Same applies to behavioral finance!

§ I am not saying efficient market hypothesis should be abandoned;

existing theories should be enhanced and extended instead
Course Outline

§ Introduction to Behavioral Economics

ü Traditional economic models
ü Is actual human behavior consistent with theory?
ü Basics of behavioral models (e.g., prospect theory, etc.)
§ Behavioral Finance: Are Markets Efficient?
ü Revisiting EMH and CAPM
ü Financial markets in reality: famous puzzles
Limits of arbitrage
ü …
§ Behavioral Corporate Finance
ü Managerial overconfidence, experience effects, etc.
§ Behavi
oralH ousehol
dFi
nance
ü Irrational household financial behavior, interventions, etc.
Course Schedule

Topic
Week 1 수업 소개/전통적 경제학적 모형에 대한 소개
Week 2 가치, 선호와 선택에서의 편향
Week 3 기대심리, 휴리스틱 측면에서의 편향
Week 4 불확실성 하에서의 합리적 선택과 그 한계 1
Week 5 공휴일 (개천절)
Week 6 불확실성 하에서의 합리적 선택과 그 한계 2
Week 7 인지편향에 대한 수업 내 토론 및 케이스 발굴
Week 8 중간고사
Week 9 행동재무론에 대한 소개: 효율적 시장 가설
Week 10 현재가치 모형이 의미하는 바는 무엇인가?
Week 11 정보, 정보에 대한 반응과 시장유동성
Week 12 금융시장에서의 행동적 편향에 대한 수업 내 토론 및 케이스 발굴
Week 13 행동 기업 재무 1
Week 14 행동 기업 재무 2
Week 15 행동 가계 재무
Week 16 기말고사
Assessment Outline

Total 100%

Attendance 10%

Discussion 10%

Assignment 20%

Mid-Term Exam 20%

Final Exam 40%

Assessment Outline

§ Attendance (10%)
Discussion (10%):
ü Two discussion sessions planned (Week 7 and 12)
ü Topic 1: What are the examples of behavioral anomalies
that you encounter personally in your daily life?
ü Topi
c2:W hatar
etheex
ampl
es ofmar
ketanomal
ies that
people observe in the financial markets?
ü Each student submits one-page summary beforehand
ü Active participation rewarded
Assessment Outline

§ Assignment (20%):
ü Related to topic 2 of in-class discussion, you are required to submit
a written report of no more than five pages in text.
ü G ui
del
ine:Tr
yandansw erthef
oll
ow i
ngquesti
ons.
.Try and find a not-so-well-known example!
1
2. Is it really an anomaly? Can you explain the phenomenon
rationally?
3. What is causing such an anomaly? Can you link to the lecture
material during the first part of the course?
4. If it is an anomaly, what are the factors that prevent the market
from correcting itself?
Assessment Outline

§ Mid-Term Exam (20%): 90 mins, short answers

§ Final Exam (40%): 90 mins, longer essays

Assessment Guideline

Three key ingredients to good grades:

1. I want to hear your views – there is no one right answer!

2. Keep calm and THINK on

Think logically and carefully before writing your report or answers.

3. What do YOU think?

Be prepared to break out of “model answers”!!
Investor Behavior and the
Financial Market

Standard Economic Model

Prof. Seungho Choi

Department of Finance
Hanyang University Business School
Starting Point: Standard Model

The standard economic model has three fundamental characteristics

about human decisionmaking:

1. PREFERENCES: how do people rank between different outcomes

based on their attitudes and values?

2. BELIEFS: what probabilities do people attach to the likelihood of

various outcomes given the available information?

3. RATIONALITY: appropriate determination of preferences and beliefs,

as well as their optimal actions given these preferences/beliefs.
Starting Point: Consumer Behavior

In most simple terms, consumer behavior is about choosing the

best consumption bundle that he/she can afford.
e.g., think of a two-good world:

Wine ( ) Beer ( )
Starting Point: Consumer Behavior
Starting Point: Consumer Behavior

This preference can be neatly represented through indifference curves:

Beer (y)

Better-Off

Wine (x)
Starting Point: Consumer Behavior

Consumer faces budget constraint:

Beer (y) Consumer’s monetary income

Budget constraint
Wine (x)
Starting Point: Consumer Behavior

Point E is the equilibrium point for the consumer:

§ It allows him/her to attain the highest satisfaction given the budget

§ Slope of the indifference curve = slope of the budget constraint

Subjective rate of substitution Market rate of substitution

§ Slope of the indifference curve is “marginal rate of substitution”

→ how much beer is the consumer willing to give up to
get one more bottle of wine?

§ Slope of the budget constraint is “relative price” of wine and beer

→ how does the market as a whole objectively value the two goods?
Axioms of the Standard Model

This standard model requires four axioms about consumer preference:

1. Completeness: a consumer should be able to compare any two

consumption choices

You have to be able to rank each and every one of them!

Axioms of the Standard Model

2. Transitivity
e.g., 3 options for choosing a venue for wedding anniversary:
- Pasta - Sushi - Dim Sum

If pasta is preferred to sushi, and sushi is preferred to Dim Sum, then

transitivity requires Dim Sum cannot be preferred to pasta

Violated more often than you think!

Axioms of the Standard Model
Further Assumptions

The standard model also requires additional assumptions:

1. Cancellation: any state of the world that results in the same outcome
for the consumer can be cancelled.

e.g., if you prefer a bottle of wine to a bottle of beer,

you have to prefer winning a bottle of wine on a rainy day (and
nothing on a sunny day) to winning a bottle of beer on a rainy day
(and nothing on a sunny day).
You win nothing if there is no rain: this shouldn’t affect your choice!
Further Assumptions

2. Dominance: if you strictly prefer wine to beer when it snows

and wine is at least as good as beer in all other weather,
wine is dominant over beer and should always be chosen.

3. Extensionality: you attach the same value to an object regardless of

how it is described, e.g., 2% fat milk vs. 98% fat-free milk

4. Invariance: different representations of the same choice problem

should never affect a consumer’s decision, and always lead to the
same choice (absolutely critical!)
Criteria for Rationality

In the context of the standard model, rationality means that:

1. Consumer’s preferences adhere to the basic rules of logic and

probability theory

2. Consumer’s preferences should be coherent

3. Consumer’s preferences should not be affected by irrelevant factors

4. Beliefs should not be incompatible with empirical observations

known to the individual