Conventional theories presume that investors ____________ and behavioral finance presumes that they ____________.
are rational; may not be rational
Some economists believe that the anomalies literature is consistent with investors ____________ and ____________.
inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; given a probability distribution of returns, they often make inconsistent or suboptimal decisions
____________ may be responsible for the prevalence of active versus passive investments management.
Overconfidence
If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors.
forecasting
Statman argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long.
mental accounting
Arbitrageurs may be unable to exploit behavioral biases due to ____________.
fundamental risk, implementation costs, model risk
__________ was the grandfather of technical analysis.
charles dow
A long-term movement of prices, lasting from several months to years is called _________.
a primary trend
The Dow theory posits that the three forces that simultaneously affect stock prices are ____________.
) primary trend
II) intermediate trend
minor trend
The put/call ratio is computed as ____________ and higher values are considered ____________ signals.
the number of outstanding put options divided by outstanding call options; bullish or bearish
Conventional Finance
Prices are correct; equal to intrinsic value.
Resources are allocated efficiently.
Consistent with EMH
Two categories of irrationalities:
Investors do not always process information correctly.
Result: Incorrect probability distributions of future returns.
Even when given a probability distribution of returns, investors may make inconsistent or suboptimal decisions.
Result: They have behavio
Errors in Information Processing: Misestimating True Probabilities
Forecasting Errors: Too much weight is placed on recent experiences.
Overconfidence: Investors overestimate their abilities and the precision of their forecasts.
Conservatism: Investors are slow to update their beliefs and under react to new information.
framing
How the risk is described, "risky losses" vs. "risky gains", can affect investor decisions.
Mental accounting
Investors may segregate accounts or monies and take risks with their gains that they would not take with their principal.
Regret avoidance
Investors blame themselves more when an unconventional or risky bet turns out badly.
Prospect theory
Conventional view: Utility depends on level of wealth.
Behavioral view: Utility depends on changes in current wealth.
Fundamental risk
Markets can remain irrational longer than you can remain solvent."
Intrinsic value and market value may take too long to converge.
implementation cost
Transactions costs and restrictions on short selling can limit arbitrage activity.
model risk
What if you have a bad model and the market value is actually correct?
Siamese twin companies
Royal Dutch should sell for 1.5 times Shell
Have deviated from parity ratio for extended periods
Example of fundamental risk
Equity carve-outs
3Com and Palm
Arbitrage limited by availability of shares for shorting
closed-end funds
May sell at premium or discount to NAV
Can also be explained by rational return expectations
Disposition effect
The tendency of investors to hold on to losing investments.
Demand for shares depends on price history
Can lead to momentum in stock prices
Dow Theory
Primary trend : Long-term movement of prices, lasting from several months to several years.
Secondary or intermediate trend: short-term deviations of prices from the underlying trend line and are eliminated by corrections.
Tertiary or minor trends: Daily
Confidence index
The ratio of the average yield on 10 top-rated corporate bonds divided by the average yield on 10 intermediate-grade corporate bonds.
dow theory attempts to
identify underlying trends in stock indexes. moving averages, relative strength, and breth are used in other trend strategies
Some sentiment indicators are
trin statistic, confidence index, and the put/call
explain how some of the behavioral biases discussed in the chapter might contribute to the success of technical trading rules
Technical analysis can generally be viewed as a search for trends or patterns in market prices. Technical analysts tend to view these trends as momentum, or gradual adjustments to 'correct' prices, or, alternatively, reversals of trends. A number of the b
Why would an advocate of the efficient market hypotheis believe that even if many investors exhibit the bahavioral biases discussed in the chapter, securitiy prices mught still be set efficiently?
Even if many investors exhibit behavioral biases, security prices might still be set efficiently if the actions of arbitrageurs move prices to their intrinsic values. Arbitrageurs who observe mispricing in the securities markets would buy underpriced secu
What sorts of factors might limit the ability of rational investors to take advantage of any "pricing errors" that result from actions of "behavioral investors"?
One of the major factors limiting the ability of rational investors to take advantage of any 'pricing errors' that result from the actions of behavioral investors is the fact that a mispricing can get worse over time. An example of this fundamental risk i
Even if behavioral biases do not affect equlilibrium asset prices, why might it still be important for investors to be aware of them?
There are two reasons why behavioral biases might not affect equilibrium asset prices: first, behavioral biases might contribute to the success of technical trading rules as prices gradually adjust towards their intrinsic values, and second, the actions o
Some advocated of bahavioral finance agree with EMH that indexing is the optimal investment straegy for most investors, compare contrast the rationale for indexing
Efficient market advocates believe that publicly available information (and, for advocates of strong-form efficiency, even insider information) is, at any point in time, reflected in securities prices, and that price adjustments to new information occur v
what is fundamental risk, and why may such risk allow behavioral biases to persist for long periods of time?
Underlying risks still exist even during a mispricing event. The market mispricing could get worse before it gets better. Other adverse effects could occur before the price corrects itself (e.g. loss of clients with no understanding or appetite for mispri
what is data mining, and why must techcnical analysts be careful not to engage it?
Data mining is the process by which patterns are pulled from data. Technical analysts must be careful not to engage in data mining as great is the human capacity to discern patterns where no patterns exist. Technical analysts must avoid mining data to sup
Even if prices follow a ramdom walk, they still may not be informally efficient. explain
Even if prices follow a random walk, the existence of irrational investors combined with the limits to arbitrage by arbitrageurs may allow persistent mispricings to be present. This implies that capital will not be allocated efficiently�capital does not i