Financial Economics Lecture 18 Behavioural Finance

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Behavioural Finance, anomalies in finance theory, and a theory of bubbles.

Financial Economics Lecture 18 Behavioural Finance

  1. 1. EC4024 Lecture 17: Behavioural Finance Dr Stephen Kinsella: www.stephenkinsella.net
  2. 2. This Time EMH/AMH Expected Utility Theory Behavioural Finance Prospect Theory
  3. 3. Recap Efficient Markets Hypothesis Adaptive Markets Hypothesis Expected Utility Theory
  4. 4. Efficient Markets Hypothesis • Arbitrage theorem holds always. • Pricing fundamentals are mean-reverting, markets are informationally efficient. • Believe that Pt* = Pt + Ut where Ut is a forecast error. Ut must be uncorrelated with any other information. • cf Pilbeam, cht 10, Shiller (2002)
  5. 5. Adaptive Markets Hypothesis EMH+Behav.Finance Markets adapt over time via financial interactions Implies no stable relationships over time Arbitrage can exist Only survival matters
  6. 6. Expected Utility Theory www.xkvd.com
  7. 7. Prospect Theory Kahneman & Tversky (1979) Theory is: people treat losses differently to gains.
  8. 8. Implications of Prospect theory Biases 1. Representativeness 2. Availability 3. Anchoring
  9. 9. Loss Aversion Endowment Effect: I place a higher value on a good I own than on an identical good that I don’t own
  10. 10. Applications & Anomalies
  11. 11. Anomalies January Effect
  12. 12. “On the basis of history, the only profitable time to hold small http://www.investmentu.com/ stocks is the month of January.quot;
  13. 13. The Winner’s Curse
  14. 14. Risk Aversion
  15. 15. Next Time NeuroFinance & Behavioural Economics in Government Read Liebowitz & Thaler (2008)

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