Behavioral Finance Course Outline

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School of Business Management, NMIMS
MBA-FT, II yr-Trim-VI, 2015-16
Course Title
Credit
Faculty
E-mail Id

:

Behavioral Finance

:
:
:

3.00
Dr. Mayank Joshipura
[email protected]

Course Description:
The Behavioral Finance flows naturally from the portfolio management. The portfolio
management shows how investors address the two basic decisions:
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 behavioral biases and their impact rational decision making
Understanding limits of arbitrage
Learn to make decisions in irrational world.

Scheme of Evaluation:
Class participation
Quiz
Group Project
End term Examination

10%
20%
30%
`

40%

Pedagogy: The course will be taught using combination of lectures and classroom
discussion on various topics and classroom experiments.
Session Plan:
Session Plan
1-2
Building blocks of Behavioral Finance:
 A brief history of stock markets-Return and risk in historical perspective.
 Are Financial Markets Efficient?
 Role of noise traders in financial markets
 Cycle of Greed, Hope and Fear and irrational traders

3-4

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
.
Bubblenomics-Its all about asset price bubbles
 History of Bubbles: Are bubbles too frequent?
 Is every bubble unique?
 Bubbles and Bubblers
 Defining, detecting and acting on bubbles
Reference Reading:
http://aswathdamodaran.blogspot.in/2014/06/bubble-bubble-toil-andtrouble-costs.html

5-6

7-8

Market frictions, regulatory constraints and Limits of Arbitrage:
Borrowing constraints, Short selling constraints, cost of shorting, Twin shares, risk
arbitrage, index inclusion and carve outs
Reference Reading:
 Can Market add and subtract by Lamont and Thaler
 The Limits of Arbitrage by Shelifer & Vishny
.
Individual Investor Behavior and influencing biases:
 Overconfidence
 Gambler’s fallacy
 Mental Accounting
 Preference for Lottery
 Herd mentality
Reference Reading:
 Investopedia note on Behavioral Finance

9-10

Prospect theory & Reference point effect (Framing)
Reference Reading:
 Deal or No Deal: Decision making under risk in large payoff game show by
Thaler et. al.

11-12

Equity premium Puzzle & Myopia: What explains high equity premium?

Reference Reading:
 The Equity Premium Puzzle by Siegel and Thaler
 Equity Risk Premium Puzzle by Mehra and Prescott
 Myopic loss aversion and equity premium puzzle by Benartzi and Thaler
13-14

Disposition effect: Problem of small gains and large losses
Reference Reading:
 Are investors reluctant to realize their losses? Terrance Odean
 The disposition to sell winners too early and ride losers too long: Theory
and Evidence by Shefrin and Statman

15-16

Volatility puzzle and Low risk anomaly & Lottery effect
 Are prices too volatile?
 Is relationship between risk and expected return positive, flat or negative?
 Preference for high volatility stocks and their underperformance
 Is low risk anomaly going to stay? Rational and behavioral explanations
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
 Risk Anomaly: A review of Literature, Nehal Joshipura & Mayank Joshipura
 A study of NSE Low volatility index and Waves LV30 Index
Momentum vs. contrarian- Under vs. over reaction, Theories of under
and over reaction
 Short term momentum vs. long term reversals
 Performance chasing behavior among individual and institutional investors
 Positive feedback trading
Reference Reading:

17-18






Does Market over react by De Bondt and Thaler
Momentum by Jegadeesh and Tatman
Momentum by Mayank Joshipura
Evidence of Contrarian Returns from India, Mayank Joshipura

19-20
 Project Presentations by students’ groups
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 course outline will be uploaded and made
available on Blackboard (except for book chapters).
Recommended books and readings:
1. Irrational Exuberance, 2nd ed, Robert Shiller, Broadway Publishing
2. Inefficient Markets by Andrei Shleifer, Oxford University Press
3. Advances in Behavioral

Finance- Volume II, Edited

by Richard Thaler (Published by

Princeton University Press and Russell Sage Foundation)
4. Behavioral Finance by Joachim Goldberg and Rudiger von Nizsch (Wiley publication)
5. Beyond Greed and Fear, by Hersh Shefrin (Harvard Business School Press)

6. Predictably Irrational, by Dan Ariely (Harper Collins)
7. Behavioral Finance by William Forbes, Wiley publication

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