Behavioral Finance Midterm 2

Front 1

Expected utility theory - rational

Back 1

-levels of wealth
-risk averse
-correct probability

Front 2

Prospect theory - behavioral

Back 2

-changes in wealth
-risk averse in gains, risk seeking in losses
-probability weights

Front 3

Bernoulli paradox

Back 3

Wealth has decreasing marginal utility

Front 4

Allais paradox

Back 4

-assigning different expected utility to identical problems
-Prospect theory explains with probability weighing function

Front 5

Is sensitivity (steepness) higher or lower in losses?

Back 5

higher

Front 6

Segregation

Back 6

updated reference point

Front 7

Integration

Back 7

no updated reference point

Front 8

Length of evaluation window

Back 8

profound effect on utility

Front 9

What leads to misjudgment of probabilities?

Back 9

1) overconfidence
2) representativeness
3) belief perseverance
4) regret aviodance
5) availability bias

Front 10

How does wishful thinking (overconfidence) contribute to misjudgment of probabilities?

Back 10

-people have unrealistically rosy views of their abilities
-the more important the task, the greater the optimism

Front 11

How does representativeness contribute to misjudgment of probabilities?

Back 11

-make inferences from sample too quickly
-hot hand effect
-gambler's fallacy effect (black is due)

Front 12

How does belief perseverance contribute to misjudgment of probabilities?

Back 12

-people cling to opinions too tightly & for too long
-confirmation bias: misinterpret evidence to go along with beliefs

Front 13

Regret avoidance

Back 13

-trying to turn failures into successes
-hold losing stocks
-double up
-sell winning stocks to avoid future losses

Front 14

Availability bias

Back 14

-more weight on known information
-invest locally

Front 15

Selective perception

Back 15

-ignore unfavorable information

Front 16

Contrast effect

Back 16

Contrasting information attracts more attention

Front 17

How does order of information matter?

Back 17

Primacy effect: more influence from first-mentioned
Priming effect: piece of information acts as catalyst

Front 18

How do people try to avoid regret?

Back 18

-favor inaction over action
-favor routine over innovative

Front 19

What does mental accounting entail?

Back 19

-Narrow framing
-Dynamic aggregation

Front 20

Narrow framing

Back 20

-evaluate individual decisions separately from other portions of wealth

Front 21

Dynamic aggregation

Back 21

-simple repetitions are unattractive if evaluated one at a time
-more willing to take risks if evaluate performance infrequently

Front 22

How do people decide to aggregate or separate events?

Back 22

whichever gives higher utility

Front 23

Neoclassical asset pricing

Back 23

decide to save or consume based on highest utility over time, determines portfolio

Front 24

How do investors determine prices of assets (Consumption CAPM)?

Back 24

How they contribute to consumption over time (asset that does well in recession trades at premium)
-beta > 0 trades at discount

Front 25

What are the bads of CCAPM?

Back 25

-equity premium puzzle
-excess stock return volatility
-predicts high correlation between stock returns & consumption growth

Front 26

Equity premium puzzle

Back 26

-requires too high degree of risk aversion
-no premium over 19th century but some in 20th century

Front 27

Excess volatility puzzle

Back 27

stock markets are supposed to be less volatile than they are

Front 28

What does the portfolio allocation perspective say about the equity premium puzzle?

Back 28

people must be confused about the relative safety of different investments over long horizons

Front 29

Why might investors be unwilling to bear risks of equities?

Back 29

myopic loss aversion:
1) loss aversion
2) short evaluation period

Front 30

Do organizations display myopic loss aversion?

Back 30

-produced by conflict of interest between pension fund managers and stockholders
-performance evaluation in short window affects managers job but pension has long window

Front 31

Explanation of excess volatility puzzle

Back 31

-run-up in price = less risk averse
-drop = more risk averse

Front 32

What is the problem with investors desiring cash dividends?

Back 32

-tax inefficient

Front 33

How might cash dividends be explained rationally?

Back 33

1) Transaction costs
2) Signaling
3) Market monitoring
4) Agency costs

Front 34

What are the behavioral explanations of cash dividends?

Back 34

1) Self-control
2) Mental accounting
3) Regret aversion

Front 35

How do investors narrow down their stock possibilities?

Back 35

-small set of attention-grabbing then use preferences

Front 36

Truth effect

Back 36

repetition creates a feeling of greater likelihood for something to be true

Front 37

Does investor attention move share prices?

Back 37

yes

Front 38

Does investor attention have a short-term or long-term effect on share prices?

Back 38

depends on for how long you are able to capture investors' attention