Behavioral Finance Course Outline
Content
School of Business Management, NMIMS MBA-Core, II yr-Sem-VI, 2013-14 Course Title Credit Faculty E-mail Id Course Description: The Behavioral Finance flows naturally from the portfolio management. The portfolio management shows how investors address the two basic decisions:
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Behavioral Finance 3.00 Dr. Mayank Joshipura [email protected]
How should they maximize the returns they make while taking on the least amount of risk? Which of the numerous investment opportunities they are offered - stocks, bonds, options, derivatives, commodities, bullions, alternative investment instruments, offers them the best combination of return and risk characteristics? In practice however, investors don't always understand risk and make systematic biases in their choices of securities and assets. According to classical finance theory, these biases should not matter. In other words, markets are efficient and prices reflect fundamental values. The reason that biases should not matter is that even if investors are biased, these biases should not be systematic. Even if investors are systematically biased, unbiased rational investors should be able to take advantage of these biases and irrational investors should eventually be driven out of the market. However, a number of researchers have documented that, contrary to the efficient markets and portfolio theory hypotheses, anomalies, both pertaining to return and risk have been observed and sustained over a period of time which cannot be explained by efficient market hypothesis in its entirety. Presence and persistence of such anomalies find explanation in irrational decision making caused by behavioral biases of market participants. The course examines, how these anomalies are caused by investor behavioral biases and exploiting opportunities arising out of that on the one hand and at the same time not falling prey to such biases while making decision for self. The course also focuses on understanding investment decisions in light of behavioral biases and impact of such biases on the behavior of asset prices. Learning Objectives: • • • Understanding limits of arbitrage Understanding behavioral biases and their impact rational decision making Learn to make decisions in irrational world.
Scheme of Evaluation: Class Participation Quiz Assignments/Project End Term Examination 10% 10% 30% 50%:
`
Pedagogy: The course will be taught using combination of lectures and classroom discussion on various topics and classroom experiments.
Session Plan: Session Plan From market efficiency to behavioral finance: Cycle of Greed, Hope and Fear and 1-2 irrational traders Reference Reading: • From Efficient market theory to Behavioral Finance by Robert Shiller • Survey of Behavioral Finance by Barberis and Thaler • Noise trader risk in financial markets by Long and Shleifer . Limits of Arbitrage: Twin shares, risk arbitrage, index inclusion and carve outs 3-5 Reference Reading: • Can Market add and subtract by Lamont and Thaler • The Limits of Arbitrage by Shelifer & Vishny .HBS CASE: Long term capital management L. P. ( C ) by Andre Perold, product no: 9200-009 6-7 Prospect theory & Reference point effect Reference Reading: • http://www.nobelprize.org/nobel_prizes/economicsciences/laureates/2002/kahnemann-lecture.pdf • Deal or No Deal: Decision making under risk in large payoff game show by Thaler et. al. Myopic loss aversion: equity premium puzzle Reference Reading: • Myopic loss aversion and equity premium puzzle by Benartzi and Thaler Disposition effect: Selling winners too early and holding on to losers too long Reference Reading: • Are investors reluctant to realize their losses? • The disposition to sell winners too early and ride losers too long: Theory and Evidence by Shefrin and Statman Volatility puzzle and Low risk anomaly & Lottery effect Reference Reading: • Benchmarks as limits to Arbitrage: Understanding the low volatility anomaly by Baker et. al. • Low risk stocks outperform within all observable markets in the world by Baker and Haugen Momentum vs. contrarian- Under vs. over reaction
8-9
10-11
12-13
14-15
Reference Reading: • • 16-17 Does Market over react by De Bondt and Thaler Momentum by Jegadeesh and Tatman
Theories of Under reaction and overreaction: Reference Reading: • Investor Psychology and Security market under and over reaction by Daniel at. al. • Competing theories of Financial Anomalies Individual Investor Behavior and influencing biases: • Overconfidence • Mental Accounting • Preference for Lottery • Herd mentality Reference Reading: • Investopedia note on Behavioral Finance Behavioral Corporate Finance: Reference Reading: • CEO Overconfidence and Investment Decisions by Malmendier and Tate • The “Winner’s curse” hypothesis and corporate takeovers by Varaiya Behavioral Finance: Road Ahead-Opportunities and challenges Reference Reading: • The end of behavioral finance by Thaler
18
19
20
Note: • While there is no prescribed text book for the course, participants are encouraged to read relevant topics from the following list of books. • All the reading material prescribed in the session plan will be uploaded and made available on Blackboard.
Recommended books and readings:
1. Advances in Behavioral Finance- Volume II, Edited by Richard Thaler (Published by Princeton University Press and Russell Sage Foundation) 2. Behavioral Finance by Joachim Goldberg and Rudiger von Nizsch (Wiley publication) 3. Beyond Greed and Fear, by Hersh Shefrin (Harvard Business School Press) 4. Predictably Irrational, by Dan Ariely (Harper Collins)
: : : :
Behavioral Finance 3.00 Dr. Mayank Joshipura [email protected]
How should they maximize the returns they make while taking on the least amount of risk? Which of the numerous investment opportunities they are offered - stocks, bonds, options, derivatives, commodities, bullions, alternative investment instruments, offers them the best combination of return and risk characteristics? In practice however, investors don't always understand risk and make systematic biases in their choices of securities and assets. According to classical finance theory, these biases should not matter. In other words, markets are efficient and prices reflect fundamental values. The reason that biases should not matter is that even if investors are biased, these biases should not be systematic. Even if investors are systematically biased, unbiased rational investors should be able to take advantage of these biases and irrational investors should eventually be driven out of the market. However, a number of researchers have documented that, contrary to the efficient markets and portfolio theory hypotheses, anomalies, both pertaining to return and risk have been observed and sustained over a period of time which cannot be explained by efficient market hypothesis in its entirety. Presence and persistence of such anomalies find explanation in irrational decision making caused by behavioral biases of market participants. The course examines, how these anomalies are caused by investor behavioral biases and exploiting opportunities arising out of that on the one hand and at the same time not falling prey to such biases while making decision for self. The course also focuses on understanding investment decisions in light of behavioral biases and impact of such biases on the behavior of asset prices. Learning Objectives: • • • Understanding limits of arbitrage Understanding behavioral biases and their impact rational decision making Learn to make decisions in irrational world.
Scheme of Evaluation: Class Participation Quiz Assignments/Project End Term Examination 10% 10% 30% 50%:
`
Pedagogy: The course will be taught using combination of lectures and classroom discussion on various topics and classroom experiments.
Session Plan: Session Plan From market efficiency to behavioral finance: Cycle of Greed, Hope and Fear and 1-2 irrational traders Reference Reading: • From Efficient market theory to Behavioral Finance by Robert Shiller • Survey of Behavioral Finance by Barberis and Thaler • Noise trader risk in financial markets by Long and Shleifer . Limits of Arbitrage: Twin shares, risk arbitrage, index inclusion and carve outs 3-5 Reference Reading: • Can Market add and subtract by Lamont and Thaler • The Limits of Arbitrage by Shelifer & Vishny .HBS CASE: Long term capital management L. P. ( C ) by Andre Perold, product no: 9200-009 6-7 Prospect theory & Reference point effect Reference Reading: • http://www.nobelprize.org/nobel_prizes/economicsciences/laureates/2002/kahnemann-lecture.pdf • Deal or No Deal: Decision making under risk in large payoff game show by Thaler et. al. Myopic loss aversion: equity premium puzzle Reference Reading: • Myopic loss aversion and equity premium puzzle by Benartzi and Thaler Disposition effect: Selling winners too early and holding on to losers too long Reference Reading: • Are investors reluctant to realize their losses? • The disposition to sell winners too early and ride losers too long: Theory and Evidence by Shefrin and Statman Volatility puzzle and Low risk anomaly & Lottery effect Reference Reading: • Benchmarks as limits to Arbitrage: Understanding the low volatility anomaly by Baker et. al. • Low risk stocks outperform within all observable markets in the world by Baker and Haugen Momentum vs. contrarian- Under vs. over reaction
8-9
10-11
12-13
14-15
Reference Reading: • • 16-17 Does Market over react by De Bondt and Thaler Momentum by Jegadeesh and Tatman
Theories of Under reaction and overreaction: Reference Reading: • Investor Psychology and Security market under and over reaction by Daniel at. al. • Competing theories of Financial Anomalies Individual Investor Behavior and influencing biases: • Overconfidence • Mental Accounting • Preference for Lottery • Herd mentality Reference Reading: • Investopedia note on Behavioral Finance Behavioral Corporate Finance: Reference Reading: • CEO Overconfidence and Investment Decisions by Malmendier and Tate • The “Winner’s curse” hypothesis and corporate takeovers by Varaiya Behavioral Finance: Road Ahead-Opportunities and challenges Reference Reading: • The end of behavioral finance by Thaler
18
19
20
Note: • While there is no prescribed text book for the course, participants are encouraged to read relevant topics from the following list of books. • All the reading material prescribed in the session plan will be uploaded and made available on Blackboard.
Recommended books and readings:
1. Advances in Behavioral Finance- Volume II, Edited by Richard Thaler (Published by Princeton University Press and Russell Sage Foundation) 2. Behavioral Finance by Joachim Goldberg and Rudiger von Nizsch (Wiley publication) 3. Beyond Greed and Fear, by Hersh Shefrin (Harvard Business School Press) 4. Predictably Irrational, by Dan Ariely (Harper Collins)
