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In-class discussion 1

In-class discussion 1. About Presentation and Essay. Choose a time slot and fill in the table 10 minutes presentation would have Q & A section Bonus credit for reading + essay. Game 1 – tea auction. Take out a piece of paper

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In-class discussion 1

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  1. In-class discussion 1

  2. About Presentation and Essay • Choose a time slot and fill in the table • 10 minutes presentation • would have Q & A section • Bonus credit for reading + essay

  3. Game 1 – tea auction • Take out a piece of paper • Write down the highest price you are willing to pay for this tin of tea. • Congratulations, you get this tin of tea for free! • Write down the lowest price you would accept to sell this tin of tea.

  4. What’s your WTP and WTA • Your first price is your WTP. • Your second price is your WTA. • In traditional finance theory, WTP=WTA=your valuation of this tin of tea. • But, look at your numbers… • Don’t worry, people behave like you!

  5. WTP<<WTA • Experimental economics/finance • Why WTP<<WTA? Or what’s wrong with traditional finance theory? • Traditional finance assume ‘traders’ in financial markets are ‘rational’. • Behavioral finance theory says ‘traders’ have emotional and behavioral patterns.

  6. Behavioral Finance Explanation • People hate to loose more than they like to gain. • If you get something, you soon become attached to it, and would ‘unrationally’ sell for a higher price than your valuation of it. • You trade ‘emotionally’!

  7. Sell price=WTA Buy price=WTP No experience traders Experienced traders Critics about behavioral finance point of view • Problematic experiments • Old friend – information problem • John List • sports card trading

  8. Related behavioral finance theories • Anchoring effect • Prospect theory

  9. back

  10. Prospective theory • Bought at $50, now trading at $55, but tomorrow there’s half chance it would be $50, half chance price be $60. -- sell now or sell later? • Bought at $50, now trading at $45, but tomorrow there’s half chance it would be $40, half chance price be $50. -- sell now or sell later? • Situation A: sell now, Situation B: sell later back

  11. Game 2 – portfolio choice • List two kinds of soft drinks that you like. • How to spend 10 dollars on these two drinks… • ‘Simple diversification’ • Suppose Ames and Kansas City both issue bonds, you can buy 10 bonds in total, how much you would buy on each? • ‘Home basis’ – insufficient diversification • ‘conservation’: too much weight on ‘base’ value

  12. Game 3 - psychology • Write down how much score you think you could get in the exam next Friday. • ‘overconfidence’ • excessive trading, trade (esp. buy) too often. • When there is a loss, tend to have optimism and wishful thinking and don’t want to ‘stop loss’. stuborn.

  13. Conclusion • A revolution of behavioral finance • Classical economics => Game theory => Behavioral economics/Finance • People on the trading floor are not as ‘rational’ as optimization machines. • Emotion, psychology, social effects come into play.

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