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7-1 the behavioral finance perspective (1 introduction (normative analysis…
7-1 the behavioral finance perspective
1 introduction
normative analysis
rational solution to the problem
traditional finance assumptions
descriptive analysis
the manner real people actually make decisions
behavioral finance explanations of behaviors
prescriptive analysis
practical advice and tools help people more approximating
efforts to use vehavioral finance in practice
2 behavioral vs traditional perspectives
3 decision making
4 perspectives on market behavior and portfolio construction
traditional perspective on market behavior
efficient market hypothesis EMH:
markets fully accurately and isntantaneously incorporate all available infor into market prices
the price is right
asset price fully reflect available infor and can be used to allocate resources
no free lunch
difficult to consistently outperform the market after taking risk into account given the inherent unpredictability of prices
the underlying assumption: market participants are rational economic beings
three forms of market efficiency
weak-form
all past market price and volume data are fully
semi-strong-form
all past and present publicly available infor is fully
strong-form
all public and private infor is fully reflected in prices
challenging the EMH: anomalies
a market anomaly must persist for a lengthy period to be considered evidence of market inefficiency
three types of identified market anomalies
fundamental
consistently overestimate the prospects of growth companies and underestimate value companies
technical
the validity of certain technical strategies
calendar
the january effect
the turn-of-the-month effect
conclusion
in reality markets are neither perfectly efficient nor completely anomalous
limits to arbitrage
the potential for withdrawal of money
→price may remain in non-equilibrium for long
→may need to liquidate prior to realizing
traditional perspectives on portfolio construction
rational portfolio：
mean-variance efficient
alternative models of market behavior and portfolio construction
a approach to consumption and savings
bahavioral life-cycle theory
incorporte self-control, mental accounting and framing biases
calssify sources of wealth into three basic accounts
current income
first spend
currently owned assets
then to spend
liquidity and maturity taken into account
the PV of the future income
to asset pricing
stochastic discount factor-based (SDF-based) asset pricing models
focuses on market sentiment as a major determinant of asset pricing
the dispersion of analysts' forecastsm - the sentiment risk premium
the discount rate capture the effects of the time value of money, fundamental risk and sentiment risk
behavioral portfolio theory:
construct portfolio in layers
exp of returns and attitudes
toward risk vary between layers
a function of five factors
the allocation to different layers depends on goals and the importance assighed to each goal
the allocation of funds within a layer depend on the goal set for the layer
the num of assets chosen for a layer depend on the shape of utility function
concentrated positions may occur
investors reluctant to realize losses may hold higher amounts of cash
the optimal portfolio
is a combination of bonds or riskless assets and highly speculative assets
adaptive markets hypothesis AMH:
applies principles of evolution to financial markets
success:survival rather than max expected utility
five implications
relationship between risk and reward varies over time
active management can add value by exploiting arbitrage oppprtunities
any particular investment strategy not consistently do well
but have periods of superior and inferior performance
the ability to adpt and innovate is critical for survival
survival is the essential objective