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Behavioral Finance

Behavioral Finance. Economics 437. Announcements. Prof Burton speaking at noon at Farmington on Tuesday, April 22 nd …. Picnic at Prof Burton’s – Sunday, April 20 th , near Foxfield, Noon to 3 PM Next midterm is April 15 th (Tuesday). Q-Group Conference.

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Announcements • Prof Burton speaking at noon at Farmington on Tuesday, April 22nd…. • Picnic at Prof Burton’s – Sunday, April 20th, near Foxfield, Noon to 3 PM • Next midterm is April 15th (Tuesday)

  3. Q-Group Conference • What determines foreclosures in the recent crisis? By Paul Willen, Boston FRS • Not sub-prime mortgages • Not “reset interest rates • Falling house prices • Main trigger: negative home equity (mortgage more than market price of home) • How Basic are Behavioral Biases? By M. Keith Chen, Yale School of Management • Capuchin monkeys • Loss Aversion

  4. Various Policy Initiatives in the Current Crisis • FNMA and FMAC • Increase mortgage size • Reduce capital requirements • Poulson recommendations • Coordinate regulations • Regulate mortgage lending at the federal level • Reid-McConnell Bill • Tax Credit for buying foreclosed homes • Tax breaks for builders and developers

  5. So, where are we? • Fama-French, 1992 • Focus on BE/ME (and ME) • They conclude that there are unknown “risk” factors • Behavioralists conclude the EMH is false • DeBondt & Thaler, 1984 (“Mean Reversion”) • Based upon 5 year periods • Buy “losers” Sell “winners” • Earn 25 % net….mostly on the purchase of “losers” • Dubbed “overreaction” or “mean reversion” • Jagedeesh & Titman, 1993 (“Price” momentum) • 3 to 12 month periods • Buy “winners” Sell “losers • Average gain of “zero cost portfolio” is 1 % per month • Chordia & Shivumkar (Earnings momentum subsumes price momentum) • 9 percent per month • Negative January effect

  6. Scott & Murillo, “The Rational Part of Momentum” • Does (price) momentum predict “fundamental value?” • What is fundamental value? (discounted dividends) • Results • “..prices lead analysts’ expectations • Or, analysts are “extrapolative” about past prices • General conclusion: there are “informed” investors who have better information and buy early • Why is this an attack on “behavioral finance” • Not a “prospect theory” argument (investors sell winners too early and hold on to losers too long) • “..our work suggests that, by and large, prices track and anticipate underlying fundamentals….”

  7. End

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