The objective of this paper is to introduce the students to the role of human behaviour in financial decision making. It discusses the various biases, Equity Premium Puzzles and arbitrage opportunities.
At the end of the course, students should be able to:
Unit 1 (2 weeks)
Introduction to Behavioral Finance-Overview, History of Behavioral Finance; From standard finance to behavioral finance- Are financial markets efficient?, Limits to arbitrage- Fundamental Risk, Noise Trader Risk, Implementation cost, evidence of limits to arbitrage
Forbes, William, “Behavioural Finance”, Student ed, Wiley Publication [chapters – 1, 2,3,4 & 5]
Unit II (3 weeks)
Cognitive biases, beliefs and heuristics-Preferences: Prospect Theory, Ambiguity aversion, Loss aversion, Framing, Non-consequentialism: Disjunction Effect, Self-deception, Neuro- finance (introduction only); Mental Accounting, Self-control, Regret avoidance and Cognitive dissonance, Representativeness and Availability, Anchoring and Belief perseverance, Overconfidence, Optimism and wishful thinking, Overreaction and Conservatism, Self- attribution, Regency bias
Forbes, William, “Behavioural Finance”, Student ed, Wiley Publication [chapters – 6, 7, 8, 9]
Unit III (2 weeks)
Endowment effect, Disposition effect, reference price effect, Herd Behavior, hindsight, winners’ curse, cognitive dissonance, familiarity bias, status quo bias, law of small numbers, information overload
Forbes, William, “Behavioural Finance”, Student ed, Wiley Publication [chapters – 10, 11, & 12]
Unit IV (4 weeks)
Application-The Aggregate Stock Market: Equity Premium Puzzle-prospect theory, loss aversion; The Volatility Puzzle-beliefs, p References:; The Cross Section of Average returns- size premium, long term reversals, predictive power of scaled price ratios, momentum, event studies
Application-The closed end funds and co movement: investor behavior (saving and investment)-insufficient diversification, naïve diversification, excessive trading, the selling decision, the buying decision.
Application-Corporate Finance: Security Issuance, Capital structure and Investment, Dividends, Managerial Irrationality.
Forbes, William, “Behavioural Finance”, Student ed, Wiley Publication [chapters – 13, 14, & 15]