Summary: Stuvia 1078607 Samenvatting Behavioral Finance 2

Read the summary and the most important questions on Stuvia 1078607 samenvatting behavioral finance 2

• 1 Lecture 1 – Introduction

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• What are the three decision-making perspectives discussed?

  - Normative: focuses on how people should make decisions, such as using NPV for project evaluation.
  - Descriptive: examines how people actually make decisions, including biases like systematic deviations.
  - Prescriptive: looks at how to help people make decisions effectively.

• What are the standard assumptions of traditional finance theory?

  - Investors and managers perfectly resemble the Homo Economicus.
  - Markets are considered perfect and informationally efficient.
  - Financial incentives can correct suboptimal behavior, and passive investing in low-cost diversified index funds is deemed optimal.

• What are the implications of the Efficient Market Fanatic view on market efficiency?

  - Belief that security prices always equal intrinsic value.
  - Claims it's impossible to accurately predict risk-adjusted returns.

• What are the beliefs of the Behavioural Finance Fanatic regarding market efficiency?

  - Argues that stock prices are solely influenced by market psychology.
  - Maintains it's easy to predict movements in stock prices.

• What is the concept of the Homo Economicus in finance theory?

  - Homo Economicus is described as a self-regarding maximizer with unlimited information processing and strong willpower.

• What is Homo Sapiens known as, and what are its characteristics?

  - Homo Sapiens are known as "wise men" but exhibit characteristics of [bounded rationality], [awareness], [willpower], and [self-interest].
  - Despite being called "wise men," they display limitations in rationality, awareness, willpower, and self-interest.

• Why did traditional finance theory emerge and persist?

  - Traditional finance theory emerged and persists due to factors such as the [desire for natural sciences], rise of computers, "as if" defense by Friedman, and belief in "market forces solving irrationalities."
  - It emerged and sustains due to reasons like a desire for scientific credibility, technological advancements, theoretical defenses, and faith in market efficiency.

• What is behavioral finance and what is its approach?

  - Behavioral finance (BF) studies how psychological phenomena affect financial behavior, examining deviations from rationality and relaxing assumptions of perfect capital markets.
  - BF extends traditional finance by looking at systematic deviations from rationality and relaxing the assumptions of perfect markets.

• 2 Lecture 2 Overconfidence & Optimism

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• What are the beliefs associated with the Homo Economicus model?

  - Utilizes all available information when marginal benefits surpass marginal costs.
  - Maintains rational expectations avoiding systematic errors.

• What are the negative outcomes associated with overconfidence and optimism?

  - Attributed to causing serious global issues like wars, fatal accidents, and wrongful convictions.
  - In financial decision making, leads to stock market bubbles, unnecessary lawsuits, overleveraging, bankruptcies, excessive securities trading, and failed mergers/acquisitions.
  - Simpler consequences include games of popularity poker and poor exam preparation.
  - The graph demonstrates that people's confidence in their responses often exceeds accuracy, which can contribute to such negative outcomes.