behavior short

8/13/2019 Behavior Short

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Question #12

8. You bought two stocks X and Y last month, atthe same price of $50 per share. Obviously you

expected both stocks to go up in price. Since lastmonth, the price of X has gone up to $60 and theprice of Y has dropped to $40. So you have made$10 per share on X and lost $10 per share on Y.Now you need money to pay for your rent.Assuming you have to sell one of the two stocks.Which one do you sell?

A: Definitely X. B. Definitely Y.

C: Probably X. D. Probably Y.

Disposition Effect

People tend to sell their winners too quicklyand hold on their losers for too long.

Paper loss Tax implications

Questionnaire

7. Imagine that you face the following pair ofconcurrent decisions. First examine bothsets of choices, then indicate the option youprefer for each.

Questionnaire

First decision: Choose

A: a sure gain of $2,400, or

B: a 75% chance to gain nothing and a 25%chance to gain $10,000.

Second decision: Choose

C: a sure loss of $7,500, or

D: a 75% chance to lose $10,000 and a 25%chance to lose nothing.

Questionnaire

6. Linda is 31 years old, single, outspoken,and very bright. She majored in philosophy.As a student, she was deeply concerned withissues of discrimination and social justice,and also participated in anti-nucleardemonstrations. Which is more likely? A)Linda is a bank teller; B) Linda is a bank tellerand is active in the feminist movement.

Questionnaire

3. In a magic shop you find a coin that youknow is biased, but you dont know whether itis biased towards heads or towards tails. If itis biased towards heads then it will, onaverage, come up heads on 2/3rds of all flips;if it is biased towards tails it will, on average,come up tails on 2/3rds of all flips.


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A severe depression like that of 1920-21 is outside

the range of probability.

Harvard Economic SocietyWeekly

Letter,

November 16, 1929.

To know that we know what we

know, and that we do not know whatwe do not know, that is trueknowledge.

Confucius

More data leads to greater overconfidence.

(Oskamp and Slovic et. al.).

Overconfidence

People take too much credit for their ownsuccesses.

This leads investors to become overconfidence.

Dont confuse brains with a bull market.

Overconfidence leads to excessive trading

Data from Discount Brokerage

78,000 Households/158,034 Accounts

End-of-Month Position Statements (1-91 to12-96)

Trades (1-1-91 to 11-30-96)

Demographic Information

Trading is Hazardous to YourWealth

Barber and Odean, 2000, Journal of Finance

Monthly Turnover and Annual

Performance of Individual Investors

0

5

10

15

20

25

1 (Low

Turnover)

2 3 4 5 (High

Turnover)

PercentAnnualReturn

MonthlyTurnover Net Return

Turnover


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"Overall, men claim more ability than dowomen, but this difference emerges moststrongly on masculine task[s].

Deaux and Ferris (1977)

Boys will be Boys

Men are more overconfident than women.

Men trade more than women.

Men lower their returns more than do women.

Percent Annual Turnover

0

10

20

30

40

50

60

70

80

90

All

Women

All Men Sing le

Women

Single

Men

Own Benchmark Annual NetReturns

-3

-2

-1

0

All

Women

All Men Single

Women

Single

Men

Does Psychology AffectPrices?

The intrinsic value of any financial asset is thepresent value of the expected future cashflows.

Prices are determined by fundamentals

Conventional wisdom among academics twodecades ago was that behavioral factors playno role in determining asset prices.


We tend to believe that, even if some peopledo goofy things, there will be rational otherswaiting to take advantage of their mistakes.

Example: Overpriced internet stocks

In the long run, price reflects fundamentalvalue

The rational will tend to survive anddominate, and will be the ones to drivemarket outcomes.


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Some behavioral finance proponents proposethat irrational behavior can affect market

outcomes, such as stock prices. More and more academics are open to the

possibility that behavioral factors affectprices.

Most economists, including the financialeconomists are skeptical about this view.


If psychological bias is unsystematic, it willnot affect prices.

Half the time the irrational were too high the other half too low, so this cancels out andis perceived as noise.

If bias is systematic, there is potential forthem to affect asset prices

Limits to Arbitrage

Transactions costs

Limited capital

Noise trader risk

Fundamental risk

Horizon

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