Behavioural Finance, anomalies in finance theory, and a theory of bubbles.

1. EC4024 Lecture 17: Behavioural Finance
Dr Stephen Kinsella: www.stephenkinsella.net

2. This Time
EMH/AMH
Expected Utility Theory
Behavioural Finance
Prospect Theory

3. Recap
Efficient Markets Hypothesis
Adaptive Markets Hypothesis
Expected Utility Theory

4. Efficient Markets Hypothesis
• Arbitrage theorem holds
always.
• Pricing fundamentals are
mean-reverting, markets
are informationally
efficient.
• Believe that Pt* = Pt + Ut
where Ut is a forecast
error. Ut must be
uncorrelated with any
other information.
• cf Pilbeam, cht 10,
Shiller (2002)

5. Adaptive Markets Hypothesis
EMH+Behav.Finance
Markets adapt over time
via financial interactions
Implies no stable
relationships over time
Arbitrage can exist
Only survival matters

6. Expected Utility Theory www.xkvd.com

7. Prospect Theory
Kahneman & Tversky (1979)
Theory is: people treat losses
differently to gains.

8. Implications of
Prospect theory
Biases
1. Representativeness
2. Availability
3. Anchoring

9. Loss Aversion
Endowment Effect: I place a
higher value on a good I own
than on an identical good that I
don’t own

10. Applications &
Anomalies

11. Anomalies
January Effect

12. “On the basis of history, the only
profitable time to hold small http://www.investmentu.com/
stocks is the month of January.quot;

13. The Winner’s Curse

14. Risk Aversion

15. Next Time
NeuroFinance & Behavioural
Economics in Government
Read Liebowitz & Thaler (2008)