Corporate Finance Paper

1664 Words Apr 9th, 2014 7 Pages
Content Behavior Biases discussed in the article 2 Other behavior biases and empirical challenges 2
Lose aversion 2
Representativeness 3
Conservatism 3
Herd behavior 4
Limits to arbitrage 5
Weak-form efficiency. 5
Semi-strong form efficiency 6
Strong-form efficiency 6
Cross country and market settings difference 6 Appendix 8 References 13

Behavior biases discussed in the article
The behavior biases that have been discussed are over-confidence and over-optimism. Those two biases lead investors to overestimate their knowledge, understate the risks and exaggerate their ability to control the situation and hence to trade excessively. Overconfidence about certain signals may cause overreaction and hence phenomena such as the book/market
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People sometimes are too slow to update their beliefs in the face of new evidence and tend to update their beliefs with the magnitude of the change which is less than rationality would require. It offers one possible explanation for Earnings Announcement Puzzle: Investors underreact to the information in earnings surprises. Rendleman, Jones and Latane (1982) showed unusual drifts in stock prices after the earnings announcements.

The second defense for EMH is that the irrational investors trade randomly and hence their trades cancel each other out. However, empirical studies show that most people deviate in the same way which doesn’t offset each other.
Herd behavior
People are influenced by their social environment and they often feel pressure to conform. Even completely rational people can participate in herd behavior when they take into account the judgments of others, and even if they know that everyone else is behaving in a herdlike manner. Scharfstein and Stein (1990) also found that professional managers may herd and select stocks that other managers select, to avoid falling behind and looking bad.

The third condition implies that arbitragers have unlimited capital and risk capacity, and that the market is frictionless. They are assumed to take the

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