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Behavioural Finance, anomalies in finance theory, and a theory of bubbles.
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EC4024 Lecture 17: Behavioural FinanceDr Stephen Kinsella: www.stephenkinsella.net
This Time
EMH/AMH
Expected Utility Theory
Behavioural Finance
Prospect Theory
Recap
Efficient Markets HypothesisAdaptive Markets HypothesisExpected Utility Theory
Efficient Markets Hypothesis
• Arbitrage theorem holds always.
• Pricing fundamentals are mean-reverting, markets are informationally efficient.
• Believe that Pt* = Pt + Ut where Ut is a forecast error. Ut must be uncorrelated with any other information.
• cf Pilbeam, cht 10, Shiller (2002)
Adaptive Markets Hypothesis
EMH+Behav.Finance
Markets adapt over time via financial interactions
Implies no stable relationships over time
Arbitrage can exist
Only survival matters
Prospect Theory
Kahneman & Tversky (1979)Theory is: people treat losses differently to gains.
Implications of Prospect theory
Biases1. Representativeness2. Availability3. Anchoring
Loss Aversion
Endowment Effect: I place a higher value on a good I own than on an identical good that I don’t own
Applications & Anomalies
January Effect
Anomalies
“On the basis of history, the only profitable time to hold small
stocks is the month of January."http://www.investmentu.com/
The Winner’s Curse
Risk Aversion
Next TimeNeuroFinance & Behavioural Economics in GovernmentRead Liebowitz & Thaler (2008)
