Professional Documents
Culture Documents
Behavioral Finance
Behavioral Finance
Behavioral Finance
2 - Prospect Theory
3 - Cognitive Biases
4 - Limits To Arbitrage
2) Mental Accounting
3) Hindsight Biases
Heuristic and Anchoring
We find that we have a hole in our pocket and have lost
$6;
1)recurrent or arbitrageable
the market is pretty efficient for these assets, at
least on a relative basis.
Fundamental Risk;
Implementation Costs.
Risks and Costs
Fundamental risk:
agency feauture
arbitrageurs aggresiveness
Risks and Costs
Implementation costs: anything that makes it
less attractive to establish a short position than a long
one.
commissions;
bid–ask spreads;
price impact;
short-sale constraints (the fee charged for borrowing a
stock, legal constraints, the cost of finding and
learning about mispricing).
Applications
FIRST APPLICATION
Underpricing of IPOs
Prospect theory is a descriptive theory of choice under
uncertainty
Prospect theory focuses on changes in wealth
Prospect theory also assumes loss aversion
Prospect theory also incorporates framing—if two related
events occur, an individual has a choice of treating them as
separate events (segregation) or as one (integration).
WE USE PROSPECT THEORY TO EXPLAIN THE
SEVERE UNDERPRICING OF SOME IPOS.
• If an IPO is underpriced
• Suppose you are the only income earner in the family, and
you have a good job guaranteed to give you and your family
income every year for life. Now you are given an
opportunity to take a new and equally good job.
• The new job has a 50/50 chance to increase by 50% OR to
reduce by X percent your standard of living each year during
your lifetime (circle the maximum X percent reduction you
are willing to accept).
RELATIONS BETWEEN THE VARIABLES
- China and Vietnam were the most willing to take risk
- Men are more willing than women to take risk with their
income and portfolio
- People who are ready to take risks with their income are
generally also more willing to take risks in their portfolio (except
Tunisia)
TRUST IS THE ASPECT OF A CULTURE
In individualistic societies, ties among individuals are loose
and all are expected to look after themselves and people have
a lower propensity for risk.
AN AWARENESS OF THE CULTURE THAT CLIENTS COME FROM
IS IMPORTANT, AND THAT INSIGHT WILL ALLOW ADVISERS TO
SERVE THEIR CLIENTS WELL.