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Behavioral Finance Economics 437 – Spring 2010 Professor Burton

Behavioral Finance Economics 437 – Spring 2010 Professor Burton. 14,000. 10,600. 8,000. 6,400. October 2007 January 2010. Anomalies. Underlying most economic theory is The rational man (woman)

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Behavioral Finance Economics 437 – Spring 2010 Professor Burton

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  1. Behavioral FinanceEconomics 437 – Spring 2010Professor Burton 14,000 10,600 8,000 6,400 October 2007 January 2010 February 18, 2010

  2. Anomalies • Underlying most economic theory is • The rational man (woman) • Maximizes utility • Subject to contraints • Possesses good information • Anomlies suggest • We have biases that stand in the way • We operate with ad hoc rules • How a question is framed affects the answer • We may not have information or be very good at processing it • Conclusion: we might behave (systematically) very differently that the rational man (woman) behaves February 9, 2009

  3. [Choose] • [$ 2,500 with probability 33 % $ 2,400 with probability 66 % Zero with probability 1 %] • [$ 2,400 with certainty] [Default] [MC Any] [MC All]

  4. [Choose] • [ ] • [ ] • [$ 2,599 with probability 33 % Zero with probability 67 %] • [$ 2,400 with probability 34 % Zero with probability 66 %] [Default] [MC Any] [MC All]

  5. [Choose] • [] • [] • [] • [] • [$ 3,000 for sure] • [$ 4,000 with probability 80 % Zero with probability 20 %] [Default] [MC Any] [MC All]

  6. [Choose] • [ ] • [ ] • [ ] • [ ] • [ ] • [ ] • [$ 4,000 with probability 20 % Zero with probability 80 %] • [$ 3,000 with probability 25 % Zero with probabililty 75 %] [Default] [MC Any] [MC All]

  7. Choices that violate Expected Utility • Choosing B and C violate expected utility • Choosing B means • U( 2400) > .33U(2500) + .66 U(2400) • Or, .34 U(2400) > .33U(2500) • Choosing C means • .33U(2500) > .34U(2400) February 9, 2009

  8. Choices that violate Expected Utility • Choosing F and G violate expected utility • Choosing F means • U(3000) > .8U(4000) • Or, U(3000)/U(4000) > .8 • Choosing G means • .2U(4000) > .25U(3000) • Or .8 > U(3000)/U(4000) February 9, 2009

  9. [Which do you prefer?] • [A sure gain of $ 30] • [80 % chance to win $ 45 versus 30 % chance to win nothing] [Default] [MC Any] [MC All]

  10. [Which do you prefer?] • [25 % chance to win $ 30 and 75 % chance to win zero] • [20 % chance to win $ 45 and 80 % chance win zero] [Default] [MC Any] [MC All]

  11. [Two stage game: First stage—you have a 75% chance of winning nothing and the game is over; 25 % chance to move to second stage of the game, which presents you with the following options. You must decide before stage one which of the two options below, you would pick in stage two] • [A certain win of $ 30] • [80 % chance of winning $ 45 and 20% chance of winning zero] February 11, 2009

  12. [25 % chance to win $ 30 and 75 % chance to win zero] [20% chance to win $ 45 and 80% chance to win zero] Must choose A or B before stage one [A certain win of $ 30] [80 % chance of winning $ 45 and 20% chance of winning zero] 25% Game ends, you win zero 75% These are the identical choices February 11, 2009

  13. [Enter question here] • [20 % chance of imminent death and 80% chance of normal life with an expected longevity of 30 years] • [certainty of a normal life with an expected longevity of 18 years] February 11, 2009

  14. [Enter question here] • [80 % chance of imminent death and 20% chance of normal life with an expected longevity of 30 years] • [75 % chance of imminent death and 25% chance of normal life with an expected longevity of 18 years] February 11, 2009

  15. [Consider new case where there is a 25% chance that the tumor is treatable and a 75 % chance that it is not. If not, death is imminent. Otherwise, the potential outcomes are as follows] • [20 % chance of imminent death and 80% chance of normal life with an expected longevity of 30 years] • [certainty of a normal life with an expected longevity of 18 years] February 11, 2009

  16. [Imagine that the US is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs have been proposed.] • [Program A: 200 people will be saved] • [Program B, there is 1/3 probability that 600 people will be saved and 2/3 probability that no one will be saved] February 16, 2009

  17. [If Program A is Adpted, 400 people will de. If Program B is adopted, there is a 1/3 chance that nobody will die and 2/3 chance that 600 people will die. Which do you favor?] • [Program A] • [Program B] February 16, 2009

  18. The End February 18, 2010

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