Behavior Finance

OBJECTIVES:

• To identify and understand systematic behavioral factors that influences the investment behavior.

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UNIT I - INTRODUCTION: WHY BEHAVIORAL FINANCE‍

The role of security prices in the economy – EMH – Failing EMH – EMH in supply and demand framework – Equilibrium expected return models – Investment decision under uncertainty – Introduction to neoclassical economics and expected utility theory – Return predictability in stock market – Limitations to arbitrage

UNIT II - DECISION AND BEHAVIORAL THEORIES

‍Nash Equilibrium: Keynesian Beauty Context and The Prisoner’s Dilemma – The Monthy Hall Paradox – The St. Petersburg Paradox – The Allais Paradox – The Ellsberg Paradox – Prospects theory – CAPM – behavioral portfolio theory – SP/A theory – brief history on rational thought – pasacl – Fermat to Friedman – savage

UNIT III DECISION MAKING BIASES

‍Information screening bias – Heuristics and behavioral biases of investors – Bayesian decision making – cognitive biases – forecasting biases – emotion and neuroscience – group behaviour – investing styles and behavioral finance

UNIT IV ARBITRAGEURS

‍Definition of arbitrageur – Long-short trades – Risk vs. Horizon – Transaction costs and short-selling costs – Fundamental risk – Noise-trader risk – Professional arbitrage – Destabilizing informed trading

UNIT V MANAGERIAL DECISIONS

‍Supply of securities and firm investment characteristics (market timing, catering) by rational firms – Associated institutions – Relative horizons and incentives – Biased managers

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