Behavioral Finance

Behavioral Finance Economics 437

Announcements • Prof Burton speaking at noon at Farmington on Tuesday, April 22nd…. • Picnic at Prof Burton’s – Sunday, April 20th, near Foxfield, Noon to 3 PM • Next midterm is April 15th (Tuesday)

So, where are we? • Fama-French, 1992 • Focus on BE/ME (and ME) • They conclude that there are unknown “risk” factors • Behavioralists conclude the EMH is false • DeBondt & Thaler, 1984 (“Mean Reversion”) • Based upon 5 year periods • Buy “losers” Sell “winners” • Earn 25 % net….mostly on the purchase of “losers” • Dubbed “overreaction” or “mean reversion” • Jagedeesh & Titman, 1993 (“Price” momentum) • 3 to 12 month periods • Buy “winners” Sell “losers • Average gain of “zero cost portfolio” is 1 % per month • Chordia & Shivumkar (Earnings momentum subsumes price momentum) • 9 percent per month • Negative January effect • Scott & Murillo “Rational Part of Momentum,” 2008 • “Informed investors” buy early • Prices “predict” future increases in fundamental value • Sadka on Liquidity • How is liquidity to be defined • Conclusion: liquidity is driving “momentum” • Kothari, Lewellen & Warner • Does momentum hold true in the aggregate • Point to “discount rate” changes as important

Petkova & Zhang, “Is Value Riskier than Growth,” 2005 • Background • LSV argued that growth was actually riskier than value • Thus EMH is false • Petkova – Zhang say “no” • Use “expected market premium” as opposed to “actual market premium” • This reverses results • Time varying betas that are “pro-cyclical”

Lewellen & Nagel, “Conditional CAPM does not explain anomalies”, 2006 • This argument is that beta can’t explain much of the returns from value stocks • Time varying betas in the wrong direction • Alpha’s positive, big and significant • Hence EMH is in trouble • Use actual “market premium” as opposed to the approach of Petkova Zhang, who use “expected market premium

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Behavioral Finance