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Behavioral Finance

Explore various dilemmas and decision-making scenarios from the perspectives of behavioral finance and economics. Examine probabilities, choices, and mental accounting. Test your understanding with a mid-term exam.

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Behavioral Finance

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  1. Behavioral Finance Economics 437

  2. Imagine that one in every thousand athletes use steroids. Imagine also that the test for steroids has a 5 % false positive rate. If a particular athlete tested positive for steroids what is the probability that that athlete was a steroid user • [0.001] • [0.020] • [0.65] • [0.95]

  3. A Dilemna • US is preparing for the outbreak of an unusual foreign disease which is expected to kill 600 people • Program A: 200 people will be saved • Program B: 1/3 probability that 600 will be saved; 2/3 probability that no one will be saved

  4. Another Dilemna • Program C: If adopted 400 people will die • Program D: 1/3 probability that no one will die and 2/3 probability that 600 people will die

  5. Concurrent Decisions: • Choose Between: • A: A sure gain of $ 240 • B: 25 % gain of $ 1,000 and 75 % chance to gain nothing • Choose Between: • C: A sure loss of $ 750 • D: 75 % chance to lose $ 1,000 and 25 % chance to lose nothing

  6. Oops • Choose Between: • A: A sure gain of $ 240 • B: 25 % gain of $ 1,000 and 75 % chance to gain nothing • Choose Between: • C: A sure loss of $ 750 • D: 75 % chance to lose $ 1,000 and 25 % chance to lose nothing • If you chose A & D: • 25 % gain of $ 240 and 75 % chance to lose $ 760 • {B & C} dominates {A & D} • 25 % gain of $ 250 and 75 % chance to lose $ 750

  7. Make a choiceYou have been given $ 2,000 • Choose between A and B • A: 50 % chance of losing $ 1,000 or receiving nothing • B: A sure loss of $ 500

  8. Make a choiceYou have been given $ 1,000 • Choose between C and D • C: 50 % chance of winning $ 1,000 or receiving nothing • D: A sure $ 500

  9. Make a choice • Choose between A and B (assuming you have been given $ 1,000) • A: 50 % chance of winning $ 1,000 • B: A sure gain of $ 500 • Choose between C and D (assuming you have been given $ 2,000) • C: 50 % chance of losing $ 1,000 or receiving nothing • D: A sure loss of $ 500 A and C are identical B and D are identical

  10. Another Choice • Which would you prefer? • A: Certain gain of $ 30 • B: 80% chance to win $ 45 and 20% chance to win $ 0

  11. Another • C: 25 % chance to win $ 30 and 75 % chance to win nothing, or • D: 20 % chance to win $ 45 and 80 % chance to win nothing

  12. And again • A Two Stage Game • 75 % chance of ending the game winning nothing and 25 % chance of going to second stage of the game • At second stage • R:Certain win of $ 30, or • S:80% chance to win $ 45 and 20% chance to win nothing

  13. Mental Accounting • Sale of two items • $ 150 Jacket • $ 5 calculator • Will you go to the store two blocks away to buy $ 145 jacket? • To get the calculator for free • Get a free ticket to go to the play. Lose the ticket that morning, will you go? • Find $ 1,000 on the street. Get a $ 1,000 unexpected dividend on your stock.

  14. First Mid Term – Thursday, March 3, 2016 • During regular class time; in Wilson Auditorium • Covers: • Lectures and Reading up to and including Feb 18, 2016 • Subjects: EMH, Noise Trading and including readings from Malkiel, Shiller, Fama, Shleifer (chapters 1 and 2), Burton-Shah, pp. 1-51. • Utility lectures: Feb 16 and Feb 18 • All lectures and powerpoint presentations up to and including Feb 18, 2016

  15. Format of Mid-Term • Five or six questions • First question: • 8 to 12 identifications • Answers need to be very precise to identification question • Four to five additional questions • Tend to be essay • Could be problems as well • Nothing is ruled out

  16. The End

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