Behavioral Finance

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Behavioral Finance

• Economics 437

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Announcements

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

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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

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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

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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

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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.

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End