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Exploring Behavioral Finance and Inefficient Markets

This course delves into Behavioral Finance and the concept of Inefficient Markets, covering key topics such as limits to arbitrage, anomalies, and the Efficient Market Hypothesis. Essential readings by renowned authors like Kahneman and Shleifer. Get ready for lectures, exams, and engaging discussions exploring the impact of noise trading and market efficiency. Join us to unravel the complexities of financial decision-making and market behavior.

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Exploring Behavioral Finance and Inefficient Markets

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  1. Behavioral Finance Economics 437

  2. Course Information • Three Books • Andre Shleifer – “Inefficient Markets” • Daniel Kahneman – “Thinking: Fast and Slow (should have already read) • Edwin Burton – Sunit Shah – “Behavioral Finance” • Richard Thaler -- Misbehaving • Online Reading at Toolkit • Reading is difficult • I-Clickers - required • Lectures • Exams • Two mid terms • Mch 3 and April 14 Final May 9: 2PM • Office Hours 11-12: Tues Thur at VNB office (not on grounds)

  3. Course Topics • Review of MPT & EMH • Limits to Arbitrage • Anomalies • Serial Correlation in Stock Returns

  4. Immediate Reading (today, Jan 21) • Malkiel (online) • Shiller (online) • Shleifer (book, Ch 1) • Fama (online)

  5. Reading (starting Jan 28)“Noise Trading” – Limits to Arbitrage • Black on Toolkit • Shliefer on Toolkit • Burton & Shah, pp 1-51

  6. The Efficient Market Hypothesis(EMH) • Price captures all relevant information • Modern version based upon “No Arbitrage” assumption • Why do we care? • Implications • Only new information effects prices • Publicly known information has no value • Investors should “index” • Allocation efficiency

  7. The Milton Friedman argument for market efficiency in the presence of “noise traders” • If noise traders are truly “random,” then their effects will “cancel out.” (Kind of a law of large numbers result) • Noise traders are “systematic,” then arbitrage traders will “trade against them” and take all of their money • Thus prices will be efficient in either case

  8. But, then • October 19, 1987 • 1992, Article by Eugene Fama and Ken French • The Tech Bubble • The Rise of Hedge Funds

  9. 1987 - The “Rip Van Winkle” Year 2700 2300 2200 2200 2200 1700 Jan July October Dec

  10. Fama and French • Both authors are staunch supporters of EMH • 1992 Article gave a simple formula to pick stocks that “beat the market” consistently • This lead “respectability” to a growing literature that simple formulae could “beat the market”

  11. The Tech Bubble • 1999 Nasdaq up 100 percent for the year • Priceline: • Came public at 20, rose to 200, fell to under 1 • No news of substance • Nasdaq peaked at 5000 in March 2000 • Fell to 1800 by 2002

  12. Hedge Funds • Industry grew from cottage industry to massive industry • Charges very, very high fees to customers • Idea: they can outperform the market; thus they deserve the big fees • Used by Harvard and Yale endowments (UVA as well)

  13. And There Things Stood • In 1970

  14. The End

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