Behavioral Fianance

QUESTION 3.

• Bias Identification, please identify the biases and/or heuristics displayed by Professor French

People make a variety of mistakes when making decisions. These mistakes are generally associated with a host of biases that occur when we use judgmental heuristics which are rules of thumb shortcuts people use to reduce information processing demands. We often use them automatically without conscious awareness. Use of heuristics helps decision makers to reduce the uncertainty inherent in the decision-making process. Because these shortcuts are representative of knowledge we gained in the past, they are useful in evaluating current problems but can also lead to systematic errors that erode the quality of decisions. In this activity, you are asked to identify several common decision-making biases

1. Professor French tells you that South Africa’s stock market undervalued and suggests that it is a good investment. You discover that South Africa is about to impose a new tax on security transactions, which will results in lower liquidity. The next class you bring this to Professor French’s attention. Simultaneously, another student mentions that as commodity prices recover South Africa’s stock market will rise sharply. Dr. French ignores the information you provide and congratulates the other student on excellent research. Which type of bias is Professor French displaying? Explain briefly.

1. While reviewing the most recent four quarters of earnings estimates for MMM, Professor French notices that earnings growth rates were 15% per quarter. He announces to the class that MMM is a growth company. Which type of bias or heuristic is Professor French falling victim too? Explain briefly.

1. Professor French’s father works for Boeing. Professor French holds 18% of his portfolio in Boeing. Which type of bias or heuristic is Professor French displaying? Explain briefly.

Maximum pages: 2 pages, double-space, size 12.

Grade: 20

Question 4.

1. What is an anomaly in finance?
2. Give three examples of anomalies that academic research has uncovered in the past two decades (make sure and explain these anomalies in detail including references).
3. If markets are efficient what would you expect to happen to these anomalies after they were discovered?.
4. What financial frictions might enable these anomalies to persist (make sure and cite frictions that apply to the anomalies in part ‘b’)?