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In-class discussion 1. About Presentation and Essay. Choose a time slot and fill in the table 10 minutes presentation would have Q & A section Bonus credit for reading + essay. Game 1 – tea auction. Take out a piece of paper - PowerPoint PPT Presentation
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In-class discussion 1
About Presentation and Essay
Choose a time slot and fill in the table
10 minutes presentation would have Q & A section
Bonus credit for reading + essay
Game 1 – tea auction
Take out a piece of paper Write down the highest price you
are willing to pay for this tin of tea. Congratulations, you get this tin of
tea for free! Write down the lowest price you
would accept to sell this tin of tea.
What’s your WTP and WTA
Your first price is your WTP. Your second price is your WTA. In traditional finance theory,
WTP=WTA=your valuation of this tin of tea.
But, look at your numbers… Don’t worry, people behave like
you!
WTP<<WTA
Experimental economics/finance Why WTP<<WTA? Or what’s wrong
with traditional finance theory? Traditional finance assume ‘traders’
in financial markets are ‘rational’. Behavioral finance theory says
‘traders’ have emotional and behavioral patterns.
Behavioral Finance Explanation
People hate to loose more than they like to gain.
If you get something, you soon become attached to it, and would ‘unrationally’ sell for a higher price than your valuation of it.
You trade ‘emotionally’!
Critics about behavioral finance point of view
Problematic experiments Old friend – information problem
John List sports card trading
No experience traders Experienced traders
Sell price=WTA
Buy price=WTP
Related behavioral finance theories
Anchoring effect Prospect theory
back
Prospective theory Bought at $50, now trading at $55, but
tomorrow there’s half chance it would be $50, half chance price be $60.
-- sell now or sell later? Bought at $50, now trading at $45, but
tomorrow there’s half chance it would be $40, half chance price be $50.
-- sell now or sell later? Situation A: sell now, Situation B: sell later back
Game 2 – portfolio choice List two kinds of soft drinks that you like. How to spend 10 dollars on these two drinks… ‘Simple diversification’
Suppose Ames and Kansas City both issue bonds, you can buy 10 bonds in total, how much you would buy on each?
‘Home basis’ – insufficient diversification ‘conservation’: too much weight on ‘base’
value
Game 3 - psychology
Write down how much score you think you could get in the exam next Friday.
‘overconfidence’ excessive trading, trade (esp. buy) too
often. When there is a loss, tend to have
optimism and wishful thinking and don’t want to ‘stop loss’. stuborn.
Conclusion
A revolution of behavioral finance Classical economics => Game theory
=> Behavioral economics/Finance People on the trading floor are not as
‘rational’ as optimization machines. Emotion, psychology, social effects
come into play.